What is Federal Estate Tax Portability?

Estate tax exemption portability is a way for a married couple to realize the full value of their combined federal estate tax exemptions through spilling over, or "porting," the exemption amount left over when one spouse passes away to the surviving spouse. This amount left over, called the "deceased spouse's unused exclusion amount," or "DSUEA," may be used by the surviving spouse to make gifts during his lifetime or through his will at death. If he chooses not to do so, or if there is still room under the exemption cap afterwards, the amount remaining when he passes away will be tax-free under federal law (upon election in a tax return filed upon the first spouse's death by his executor).

The concept of federal estate tax exemption portability became permanent under the American Taxpayer Relief Act of 2012. In 2013, the federal estate tax exemption for each spouse was $5.25 million. Taking the simplest example - assuming that no gifts were involved - in a situation where at Spouse 1's death, Spouse 1 owns property totaling $4 million and Spouse 2 owns property totaling $7 million, $1.25 million ($5.25 million minus $4 million) is "ported" from Spouse 1's to Spouse 2's estate. Spouse 2 now has own his $5.25 million federal tax exemption, plus his deceased spouse's DSUEA of $1.25 million, for a total of $6.5 million.

How does this concept affect estate planning?

The clearest effect of permanent portability is that it cuts out the "middleman" - the "credit shelter" trust. If you want to look at it another way, portability codified credit shelter trusts ("CST"). CSTs were used prior to portability to achieve the same effect. In the absence of portability, where Spouse 1 had some amount of money still remaining under his federal exemption cap, the excess money would be put into the CST. Typically, the Spouse 2 would have rights to the income and possible principal at Spouse 1's death. The effect of the trust would be twofold:

  1. It would have all of the benefits common to trusts generally, shielding assets from creditors chief among them, and
  2. It would allow Spouse 2 and other beneficiaries to benefit from the trust assets (including any appreciation accruing to those assets) without having them considered Spouse 2's own.

If such a trust were not created and Spouse 1 left his assets to Spouse 2 outright, Spouse 2 would have more assets at death, but the same estate tax exemption - meaning a higher level of taxable property and a smaller estate to leave to his own beneficiaries. In other words without portability or a CST, the above married couple example would be taxed on the excess of $5.25 million on the second spouse's death. With portability or a CST, the entire estate is "shielded" from federal estate taxes.

While portability seems like a win-win situation, cutting out the need for - and expense associated with - a "middleman," there are a number of disadvantages to be aware of that portability does not address.

First, portability is a federal concept. There is still the state estate tax in many states. For those living in D.C. or Maryland, a CST might be needed to address Maryland and D.C.'s state estate tax on estate assets in excess of $1 million. This might occur if the couple did their estate planning with reference only to federal portability, without considering state taxes as well. Further, to avail the second spouse's estate with DSUEA, a federal estate tax return will need to be filed on the first spouse's death. Filing the return will incur costs that might seem unnecessary at the time of the first spouse's death. This is a particularly a tricky issue, if the couple does not have a taxable estate at the first spouse's death. This will obviously be a very individualized inquiry, unique to each couple's financial situation and the state in which they live.

Another disadvantage of portability with respect to a CST is the ability of the CST to protect future increase in value of assets that portability cannot. The value of the assets placed into the CST is frozen at the time of the first spouse's death. For example, if the assets placed into the trust are valued at $4 million at the time of the first spouse's death and double in value before the second spouse dies 10 years later, the entire $8 million will be excluded from the surviving spouse's estate even if the exemption level has not yet reached that level. Portability only freezes the value of the assets at the time of the first spouse's death not the increases.

Notwithstanding federal estate tax exemption portability, couples may still want to employ a trust for its flexibility. This flexibility allows a trust to better provide for changing family dynamics, especially in the case of blended families; enables the testator to delay granting money outright to a minor child in favor of waiting until he or she comes of legal age to inherit it; and allows for the avoidance of probate, among other advantages. Note, too, that it is possible for Spouse 1 to both transfer some of his assets to Spouse 2 and place other assets in a trust. The multitude of scenarios available to savvy estate planners underscores the need for formulation of a strategy to protect the maximum value of one's assets in the way that best suits his needs. Portability can be an important player in this formulation, but it is not the only consideration in a well-tailored estate plan.

Basics of Estate Planning: What is Fiduciary Responsibility?

Last time, I wrote about the basic differences between a personal representative and a trustee. Important additions to this discussion are the questions of how to go about selecting a representative or trustee, and traps to avoid falling into when managing someone else's assets or estate. Recall from the October article that both a personal representative and a trustee are fiduciaries. Along with this responsibility comes potential liability for breach of fiduciary duty, which can take various forms. Fiduciary responsibility is premised on the requirement that the fiduciary put the interests he/she is serving (the decedent's estate for a personal representative; the trust's beneficiaries for a trustee) ahead of his/her own. When the fiduciary's own interest becomes intermingled with or is put above those the fiduciary is charged with carrying out, legal liability can arise.

With this in mind, choosing a personal representative or a trustee is an extremely important task. The biggest thing to look out for in doing so is any potential conflict of interest that may come up. One of the most common conflicts of interest is naming one of your trust's beneficiaries as its trustee poses an obvious problem. Happens all the time when parents name a child to be the trustee of a parent's trust and there are other siblings involved. It may be hard for the trustee to be completely objective in administering the trust, which can cause serious legal issues as well as wreaking havoc on family unity. The same goes for a personal representative. These problems generally do not arise where there is only one beneficiary.

To minimize potential conflicts of interest, the selection of a third party will be able to carry out his duties independently of any personal stake in the proceedings. This person – or entity – should be on good terms with your beneficiaries, so that communication between the two can be maintained without issue. It is also important to keep in mind that where complex financial affairs or extensive assets are involved, a corporate trustee or representative may be better suited to properly execute the duties required than a family member or close friend. There is also the possibility of appointing co-fiduciaries as a way of eliminating potential conflict of interest issues. This may be a good solution for those who wish to balance the financial expertise of a corporate entity with the personal knowledge of your affairs and wishes of a family member or friend. For more on basic considerations when choosing a personal representative, click here. The obvious big drawback with a corporate fiduciary is that they generally costs more money than a non-corporate trustee. To read more about what a corporate fiduciary could be helpful click here.

Having said that, even taking the utmost care in selecting a representative or trustee may not alleviate all potential problems arising from breach of fiduciary duty. It is important to note that not all breaches are intentional - many result from mismanagement, failure to meet deadlines and, in the case of a personal representative, failure to adequately protect the estate's assets, leading to losses to the estate, or failure to appropriately value those assets, leading to tax penalties.

If a friend or family member asks you to serve in a fiduciary capacity, it is important to know what is required of you, as well as where liability can arise so you can make sure to avoid it. Make sure, first and foremost, that you understand the scope of your responsibilities and are prepared to carry them out. Maintain confidentiality where required, comply with all deadlines, maintain open lines of communication with the beneficiaries and be sure to document all transactions you undertake as a personal representative or trustee, making sure they are within your lawful authority by virtue of your position. For more in-depth information, see numerous past articles in my prior newsletters.

Estate of the Month: Michael Jackson's Estate Administration is Still not Over?

Michael Jackson, the King of Pop may have died in 2009, but his estate continues to rake in the millions to this day. As the money keeps pouring in, the legal controversies over the administration of his estate also continue. The controversies are exacerbated by the poor state of Jackson's financial affairs prior to his death. A recent Forbes article listed Michael Jackson as the top-earning dead musician of 2013 by a landslide, at $160 million. (Elvis, the second-place earner, came in at $55 million.) You can see the rest of the top earners here.

What sets Jackson's continued posthumous earning potential apart from other famous musicians? Well, there's the music, of course. He continues to earn royalties from the sales of his own songs - plus, he has a 50% ownership stake in Sony/ATV, the largest music publishing company in the world. Sony/ATV holds the copyrights to songs by such hugely popular musicians such as The Beatles, Eminem, Taylor Swift and others. In addition to music royalties, Jackson's estate has partnered with Cirque du Soleil to produce two Cirque shows incorporating Jackson's songs - one performed in Las Vegas, and the other in various cities around the world. These shows, called "One" and "Immortal," respectively, combine Cirque du Soleil's famous awe-inspiring feats with Jackson's hits, keeping his songs - and his name - in the public eye.

But while Jackson's estate is far and above bringing in the most money compared to those of other distinguished deceased musicians, it has also been plagued by legal troubles. You may remember that these troubles began long before MJ passed away. He had extremely valuable assets. He also an extreme income level but, he also had exorbitant costs. Jackson spent huge sums on his "Neverland" ranch (itself the subject of controversy in a 2005 child molestation trial, which couldn't have been cheap either).

Jackson's estate is making news again. This time in a lawsuit between the IRS and his estate. His co-executors, John Branca and John McClain, are disputing the legitimacy of the taxes and penalties levied on Jackson's estate by the IRS. Branca and McClain are arguing that they properly valued Jackson's estate's property. Branca and McClain argue that they paid the estate tax on what the estate owed - namely, the value of MJ's property in excess of $3,500,000i.

Recall from this month's article on breaches of fiduciary duty that undervaluing the assets of an estate while acting as the estate's executor can have serious legal consequences. This lawsuit will play out over precisely that issue.

Were Jackson's assets properly valued? Perhaps. A mega-star like Jackson does not have the run of the mill stock account. The inquiry into his estate's value will be much more complicated than it would be for you or me. How does one put a "value" on Jackson's intangible star power? And with respect to his physical assets, how would one go about valuing, for example, Jackson's "Neverland" ranch. The ranch was notoriously poorly managed and the scene of several alleged scandals. The complexity of his estate's assets can bring about divergent views on their value.

One thing is for sure - the King of Pop is still in the limelight. Whether his estate will emerge from its legal battles victorious remains to be seen.

iThe federal estate tax exemption for a person dying in 2009, the year of Jackson's death, was $3.5 million.

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