Use of Exemptions

• Author: Jerold I. Horn
• Profession: Lawyer
• Pages: 143-180

143

PART ON E

OWNERSHIP AND PAYMENT ARRANGEMENTS

The estate tax and generation-skipping tax exemptions permit a person to benet him-

self or herself and his or her spouse and, upon the death of the survivor of himself or

herself and his or her spouse, benet other beneciaries, free of estate tax and genera-

tion-skipping tax. Nevertheless, unnecessary liability for tax can occur if a spouse dies

without using his or her exemptions, under circumstances in which the assets of the

predeceasing spouse will cause the surviving spouse to have assets that will exceed the

exemptions of the survivor.

The ability to use the exemptions of each of two spouses, regardless of which spouse

dies rst, can depend upon the manner in which a married person owns his or her assets

during his or her life and provides for their transfer upon his or her death. The use of

the exemptions of a predeceasing spouse can require that the predeceasing spouse trans-

fer his or her property in such manner as does not cause the surviving spouse to own

(or be deemed to own) it.

The procedure known as “portability” can permit a surviving spouse to use any unused

portion of the United States estate tax exemption of his or her last predeceased spouse.

However, portability does not apply to the generation-skipping tax or to the estate taxes

of at least some states. Further, it does not avoid tax upon increases in value that occur

after the death of the predeceasing spouse.

A lawyer can prepare documents that can implement the clients’ plan. However, the

clients must arrange the ownership and transfer of their assets in such manner as enables

the documents to operate properly.

A prerequisite to the ability of each spouse fully to use all of his or her exemptions

is that each must own, in his or her separate name (or in the name of the trustee of his

or her revocable trust), assets which (unlike, for example, assets held between spouses

in joint tenancy or tenancy by the entireties or assets that pass from a predeceasing to

a surviving spouse by means of a beneciary designation) will not pass outright to the

surviving spouse. Assets that are intended to use exemptions must not be subject to

payment arrangements (such as, for example, joint tenancy, tenancy by the entireties,

4

Use of Exemptions

Chapter 4144

community property with right of survivorship, transfer-on-death, payable-on-death,

and beneciary designation) that “force” the assets outright to a surviving spouse. For

purposes of this analysis, assets that can serve this function are “Shelterable Assets,”

meaning assets that are owned by a spouse and that upon the death of the owner can

benet the surviving spouse without the surviving spouse having to become the owner

for estate tax purposes. Further, the words Maximum Exemptable Amount of a spouse

describe the largest of the exemptions that (after taking into account prior uses) is avail

-

able to the spouse.

1.

If the sum of the values of the Shelterable Assets of the two spouses exceeds in

value the sum of the Maximum Exemptable Amounts of the two spouses, each

spouse should own Shelterable Assets at least as great in value as his or her Maxi-

mum Exemptable Amount.

2.

If the combined net worth of the two spouses is less than the sum of the least

available exemption of one spouse and the least available exemption of the other,

no lifetime adjustment of ownership is needed between the spouses, and each can

leave all of his or her assets outright to the other without attracting liability for

United States or state estate tax.

3.

If the value of the Shelterable Assets of one spouse exceeds his or her Maximum

Exemptable Amount, and the value of the Shelterable Assets of the other spouse is

less than his or her Maximum Exemptable Amount, the rst should make lifetime

gifts of Shelterable Assets to the second to the extent of the lesser of (i) the insuf-

ciency of the second and (ii) the excess of the rst.

4.

If the value of the Shelterable Assets of one spouse exceeds his or her state estate

tax exemption that effectively is available but does not exceed his or her Maximum

Exemptable Amount, and the value of the Shelterable Assets of the other spouse

is less than the state estate tax exemption that effectively is available to the other

spouse, the rst should consider making lifetime gifts of Shelterable Assets to the

second to the extent of the lesser of (i) the insufciency of the second and (ii) the

excess of the rst.

Lifetime gifts from the donor spouse outright to the donee can accomplish desired

adjustments. The donor should not make any gift to the revocable trust of the other

spouse. Outright gifts between spouses who are citizens of the United States are deduct-

ible for gift tax purposes, without limit. By contrast, gifts from a person to a spouse who

is not a citizen of the United States are not deductible, but to the extent of an aggregate

of a particular amount of outright gifts during any calendar year they are excludable,

from the taxable gifts of the donor. Any change of ownership, and any contribution to

any joint tenancy or tenancy by the entireties, under circumstances in which the donor

145Use of Exemptions

increases the value of the interest of the donee and is unable unilaterally to restore the

increase to himself or herself, is a gift for this purpose. This analysis is subject to these

special rules for gifts to noncitizen spouses.

Even if upon the death of a person too much of his or her property appears destined

to pass outright to his or her surviving spouse, and thus not to use the exemptions of

the person who died, the survivor might salvage some or all of the exemptions of the

predeceasing spouse by using a disclaimer. By means of a disclaimer, the survivor can

avoid the receipt of the disclaimed property and, instead, cause the disclaimed assets to

pass to a trust for the benet of the disclaimant. Still, not even this type of planning can

salvage a situation in which too little (rather than too much) property ows from the

predeceasing spouse. Accordingly, proper titling is important even if the possibility of

disclaimers is being contemplated.

Not all (or, in a given case, even necessarily any) assets are Shelterable Assets or avail-

able to use as Shelterable Assets.

(a) First, any assets that should pass outright to the surviving spouse upon the death

of the predeceasing spouse are not available.

(b) Second, upon the death of the owner, certain assets, such as interests in qualied

plans of deferred compensation, individual retirement accounts, and tax-deferred

annuities, produce better results for income tax purposes if they are payable outright

to a surviving spouse rather than to a trust. Accordingly, absent special circum-

stances, the preferred planning usually is (i) to name the surviving spouse as rst

beneciary of interests in qualied plans of deferred compensation and individual

retirement accounts and (ii) to provide for passage to a trust only to any extent that

the spouse disclaims. Thus, usually, these interests are only conditionally available

to use the exemptions of the owner upon the death of the owner, and the use of

other assets usually is preferable.

(c)

Third, during the life of the owner, the mere transfer of certain assets (such as

interests in qualied and nonqualied plans of deferred compensation, individ-

ual retirement accounts, tax-deferred annuities, and any other assets that include

income not yet taxed) can accelerate the recognition of income for income tax

purposes. Accordingly, these assets generally are not available for transfer during

the life of the owner.

(d)

Fourth, because life insurance tends to “blossom” into full value only upon the

death of the insured and in any event is subject to inclusion in the gross estate of

the insured if the insured survives and has control and enjoyment of the insurance

similar to his or her control and enjoyment of the other assets of the predeceasing

spouse, a given policy of life insurance tends to use the exemptions better when

the insured rather than the spouse of the insured is the owner.