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
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
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
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