law offices of merwyn j. miller
191 calle Magdalena, suite 270 • encinitas, San Diego County, ca  92024 • 760-436-8832

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What Does the New Estate Tax Law Mean to Me.....   
                                      Part 2



Does Portability Mean the End to A-B Trusts?

How Does One Claim the Portable Exemption?

So What Should I do?

Introduction: You are probably aware that President Obama signed the Tax Relief Act on December 17, 2010. That law created a number of changes and updates that probably will affect you. We spoke about the exemption increase in last month’s edition.

Portability: As we saw in last month’s edition, Congress granted a large exemption increase to the death tax law (officially known as the Estate Tax). Then Congress sweetened the deal by allowing the exemption to be portable between spouses. That means that when the first spouse dies, if his estate is valued at less than the exemption amount ($5 million) any unused amount is added to the surviving spouse’s exemption.

This change essentially doubled the exemption (to $10 million) for spouses. The thinking was that spouses using an A-B Trust could get the exemption doubled so why shouldn’t spouses who are not aware of this option or choose not to use it.

At its base level this concept is much simpler than it sounds. For example, let’s assume husband and wife are worth $3 million together and it is all owned 50% by each (as community property would be). Husband dies. His estate is half of the whole so it is $1.5 million. He is entitled to an exemption of $5 million. But with an estate of $1.5 million he will leave $3.5 million of unused exemption (5-1.5=3.5). That $3.5 million of unused exemption can be “ported” over to the wife so that her exemption, when she dies, is $8.5 million (her initial $5 million plus the husband’s unused $3.5 million).

Does Portability Mean the End to A-B Trusts? Not really. A-B Trusts are superior to portability. Typically, with A-B Trusts, at the first death, approximately half of the combined estate of the couple (but no more than the exemption amount) is placed into the B (the Decedent’s side of the) Trust. The assets in the B Trust can (and often do ) appreciate to the point that they far exceed any exemption. But if they were exempt at the death of the first spouse to die, they remain exempt when the second spouse dies. Again, an example may help. Let’s take the same couple with a combined estate of $3 million. Husband dies. We place half of the estate ($1.5 million) into the B trust. At the time of Husband’s death Wife is young and has a well paying job. She lives a long and happy life and never really needs any money from the B trust. When she dies, the $1.5 million has grown to $10 million. Even if the exemption amount is still $5 million, the B trust assets are completely exempt from death tax.

Let’s compare what would happen if there were no A-B Trust in this situation. The husband’s half was $1.5 million. With or without an A-B Trust, this amount would be exempt from estate tax. He had $3.5 million of unused exemption left so that was ported over to the wife. She now has $8.5 million of exemption as explained above. The $1.5 million of the husband increases to $10 million by the time Wife dies. (To keep our comparison “fair” we are assuming that her $1.5 million was zero by the time she died.) Wife’s exemption amount of $8.5 million leaves $1.5 million (10-8.5=1.5) subject to tax. At a 35% tax rate the tax is $525,000. That is the difference between with the A-B approach and without it.

A-B Trusts also have creditor protection and other aspects that can make them a desirable estate planning tool depending on the circumstances and the client’s desires.

How Does One Claim the Portable Exemption? Here’s the rub for middle class families! In order to claim the unused exemption of the first spouse to die, a death tax return must be filed with the IRS within nine months of the date of death plus any extensions that are granted. Now that may not seem like much if you have never seen a death tax return. However, that return is typically much longer than any income tax return you may have had prepared.

To determine the unused exemption, one must itemize each asset that the person owned, obtain a value for it, determine deductions, etc. Having prepared many death tax returns over my career, I can tell you that it is rarely a simple job. So there will be an unexpected expense here for the surviving spouse. In fact, the preparation of a death tax return typically costs more than what an attorney charges to add A-B provisions to the standard trust.

So What Should I Do? We recommend to our clients that we get together every two years to review where they are as far as net worth, where the law is, and what their desires are. It is only by reviewing things periodically that one can feel comfortable that the person is on the correct course.