Back in the 1980’s and 1990’s, when most of us first did our living trusts, Estate Attorneys and Accountants chanted the praises of dividing our estates into two or three parts when the first spouse died.
What we were told then was right: the best way to avoid probate and at the same time reduce or eliminate Estate Taxes was to slice the trust in two at the first death to take advantage of the $600,000.00 that each partner in a marriage could pass on to children without any tax bill to pay.
For most people, that eliminated the possibility of an estate tax. Now, in 2015, the Tax Code allows each spouse–alone– to pass $5,430,000.00: more than nine times the tax free estate that earlier rules allowed. This is great, but what about our trusts that say the surviving spouse still must divide the trust in two, when the combined assets the survivor owns has may be only 10% of the tax free amount (the “Exemption”) for one person?
Quite simply, the exemption is so high that most people will not want their trusts to require a division at the first death (although there may be some rare situations where it still makes sense). For those folks, there is an option which you might call the “Wait and See” alternative for living trusts. The American Tax Relief Act of 2012 (ATRA) allows a choice between spouses when it comes to estate taxes called “Portability.”
Basically, the surviving spouse has the option to not do an immediate division of the estate at the first death, but instead, to file an Estate Tax Return and “elect” to apply the unused Exemption of the deceased spouse at a later time if it is needed due to changes such as fluctuations in either the amount of their estate or the amount of the tax free amount allowed in the Tax Code.
This is great news, since we really don’t want to have to file a second tax return every year for the “Split” trust which the division at first death creates. Instead, we want to just preserve the ability to use the tax free exemption that our deceased partner had when she or he died in case we need it later. Why make our trust more complicated if we don’t need to?
But beware of two things: first, we need to change our trusts to allow this “option” by having it modified to permit the surviving spouse to not divide the trust in half at the first death; and second, we need to have our attorney modify the document to allow the trustee to file an estate tax return (Form 706)even if no tax is due so that the surviving spouse can make the “Portability Election.”
And remember: if you don’t make this election by filing the Estate Tax Return within 9 months after your spouse dies, then you lose the Option unless you have already requested an automatic 6-month extension of time to file on Form 4768. If you wait until after the 9 months pass to file the election, the Option is not available.
Some advisors feel the completion of a portability election for smaller estates is not necessary. However, remember two factors: first, an estate may grow unexpectedly following the first death, and second, Congress could change the amount of Estate Tax Free assets we are allowed to pass tax-free when we die. The Portability Election is an easy option to protect our heirs from either possibility.