We have all heard the rumors about the New Jersey Legislature repealing or modifying the New Jersey estate tax. Well, now it’s no longer a rumor. New Jersey is one of two states that has two, separate death taxes; an estate tax and an inheritance tax. The New Jersey legislature recently voted to repeal the state’s estate tax as part of a deal to include a 23-cents-a-gallon tax hike to renew the state Transportation Fund. The state estate tax exemption would go up from its current low $675,00 to $2 million for deaths as of Jan. 1, 2017 and the complete estate tax repeal would be effective as of Jan. 1, 2018.
While the estate tax is being repealed, the inheritance tax is here to stay. As a brief recap, the estate tax is based upon the value, or amount, being left to the heirs as opposed to the inheritance tax which is based upon the relationship of the person that is receiving the inheritance to the decedent.
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Before we get into the reasons to continue to utilize credit shelter trusts, what is portability? Portability of the federal estate tax exemption between married couples means that if the first spouse dies and the value of the estate does not require the use all of the deceased spouse’s federal exemption from estate taxes, then the amount of the exemption that was not used for the deceased spouse’s estate may be transferred to the surviving spouse’s exemption so that he or she can use the deceased spouse’s unused exemption plus his or her own exemption when the surviving spouse later dies.
While, at first blush, it may seem as if there will be no need for credit shelter trusts moving forward, due to “portability of the deceased spousal unused exclusion amount,” there are other important reasons to consider utilizing a credit shelter trust in your estate plan rather than relying solely upon portability.
First, only the federal exclusion is portable. If you reside in a state that does have an estate tax, the state exclusion is not portable. Even individuals who live in a state that does not impose an estate tax should be concerned as the surviving spouse may not continue to reside in the same state. And let’s be honest, tax laws change constantly.
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Second, although the basic exclusion amount is indexed for inflation starting next year, a deceased spousal unused exclusion amount is not. Thus, portability of the deceased spousal unused exclusion amount could be significantly less beneficial than using the deceased spouse’s unused exclusion through a credit shelter trust. Growth of assets within the credit shelter trust will pass estate tax free to future heirs. Portability is limited and growth may cause the estate to be taxable.
Third, portability requires an affirmative election. Section 2010(c)(5)(A), as amended by the Tax Relief Act, provides that portability occurs only if the executor of the estate of the deceased spouse makes an election by timely filing an estate tax return. This means that if the executor fails to file, portability is lost. Or, in the alternative, if there is no reason to file, you must still file, incurring additional costs, in an effort to maintain portability that could have been accomplished through a credit shelter trust.
Fourth, the GST (Generation Skipping Transfer Tax) exemption is not portable. Any taxpayer concerned about portability probably should also be concerned about planning for GST purposes.
Fifth, portability requires “privity” between spouses. If you look at the definition of “deceased spousal unused exclusion amount,” it references only the “the last such deceased spouse.” Thus, only the estate tax exclusion of the immediately predeceased spouse of the surviving spouse is portable. This may become significant if the surviving spouse remarries and then survives his or her new spouse.
Sixth, trusts provide benefits beyond mere transfer tax savings. Non-self-settled discretionary “spendthrift” trusts are a great vehicle for providing asset protection. In addition to the creditor protection this provides, assets can be protected from bankruptcy and divorce in a trust. With portability, however, the inherited assets are fully subject to all of the surviving spouse’s present and future creditors. Further, a trust can provide for the ultimate disposition of the trust fund at the termination of the trust, which will most often be upon the death of the surviving spouse. With portability, disposition of the deceased spousal unused exclusion amount is solely in the hands of the surviving spouse. This is most often a problem where both spouses have children from prior marriages and one spouse dies.
I would be remiss, however, in not pointing out a couple of scenarios where portability may be beneficial. First, assets such as an individual retirement account, are, for income tax reasons, often inappropriate to leave to a credit shelter trust if they can be left outright to the surviving spouse without current or future estate tax. Second, assets held in a credit shelter trust will not have their basis stepped up to fair market value at the death of the surviving spouse.
A final tax analysis can be accomplished to determine whether a credit shelter trust or portability is more efficient as long as the estate plan is set up with sufficient flexibility. We encourage our clients to set up an estate and tax planning meeting in order to best craft a flexible estate plan to take advantage of all possibilities.