“Even though the federal estate-tax exemption is $5.49 million and just under $11 million for a couple, you still need to think carefully about whether to pass that “exempt” amount of wealth on to your surviving spouse through a trust.”
Barron’s recent article, “How to Protect Your Estate-Tax Exemption, explains that federally “exempt” wealth is still subject to state estate taxes. Typically, credit-shelter trusts (also called “bypass trusts”) are used to protect assets exempt from federal estate taxes, less any gifts made to your children while you’re alive. A more recent development is “portability.” This lets that same estate-tax-exempt wealth be transferred on death to the surviving spouse without a trust. However, portability has some limitations.
An option between portability and credit-shelter trusts—or a combination—is still a critical component of estate planning, despite the federal estate-tax exclusion dramatically increasing over the years. Twenty years ago, it was an easier decision: in 1997, the estate-tax exemption was only $600,000 and the top estate-tax rate was 55%. Credit-shelter trusts were popular to avoid some onerous taxes. The exemption then began to creep up to the current $11 million for a couple. In 2012, Congress enacted portability to remove the need for credit-shelter trusts for married couples.
Some experts say that a credit-shelter trust is better than portability, even for couples below the $11 million level. However, portability doesn’t exempt state estate taxes. There are 18 states and DC that have either estate or inheritance taxes of various amounts and rates. There’s also no generation-skipping with portability. The surviving spouse can’t take the $5.49 million estate-tax exemption she got via portability, and place it in a tax-free trust for her grandchildren. She also can’t protect appreciating assets from capital gains. Portability won’t protect the assets of a new spouse if the surviving spouse remarries or from stepchildren.
Credit-shelter trusts also have some cautions. If you place a primary residence in a trust, there will be mortgage problems because banks don’t want to lend money to a trust. A house in a trust doesn’t get a further stepped-up value after the surviving spouse dies. Therefore, if the children want to sell the house, they may have a sizeable capital gains tax on the difference in value between the two deaths.
If you live in a state with an estate tax, you may want to ask your estate planning attorney about putting the amount of the state tax exemption in the credit-shelter trust and elect portability for the balance of the estate up to the $5.49 million.
Any major change in the estate tax exclusion, the capital-gains rate or a repeal will impact your decisions. Talk with an estate planning attorney to learn about the character of your assets and what kind of planning approach will work best for you.
Reference: Barron’s (March 25, 2017) “How to Protect Your Estate-Tax Exemption”