This is another in a series of blogs on the basics of estate planning.

Prior to the advent of “portability,” estate planning attorneys used a “credit shelter trust” as the gold standard to preserve the estate tax exclusion of the first spouse to die. Assets up to the exclusion were placed in the trust for the benefit of the surviving spouse and descendants. The assets in this credit shelter trust pass to designated beneficiaries free from estate tax upon the death of the surviving spouse. Here are a few reasons this may still be the best way to proceed:

1. The client may not be confident that their spouse will leave assets to whom or in the manner desired by the predeceasing spouse. For example, the surviving spouse may give the assets outright to a child whom the predeceasing spouse knows should get a lifetime trust to protect the assets due to substance abuse. Even worse, the surviving spouse could remarry and the predeceasing spouse’s assets could end up with the children of the new marriage, or with the new spouse rather than the descendants the predeceasing spouse intended to benefit.
2. Portability is not effective for GST exemption, only for the gift/estate tax exclusion. GST exemption is a great way to avoid inclusion in the taxable estate of the next generation. GST exemption is lost if portability is used.
3. Portability only carries over the exclusion in effect at the date of death. The credit shelter trust exempts assets and any growth on them from estate taxes. If the first spouse dies with a $5 million exclusion, with portability the survivor will get exactly $5 million of exclusion to cover assets in the survivor’s taxable estate. If those assets have grown to $10 million or $100 million, that won’t get very far. If $5 million of assets were in the credit shelter trust and grew to $10 million or $100 million, they would all be free from estate tax, and could be GST exempt, too.
4. In most states, portability is not available for state estate tax exclusion. So, even though the federal estate tax exclusion is carried over to the surviving spouse, the predeceasing spouse’s state estate tax exclusion would be lost. With a credit shelter trust, the exclusion would not be lost.
5. Planning to use portability assumes the assets are going outright to the surviving spouse. If the assets are left in a credit shelter trust, that trust may be drafted to protect the assets from the surviving spouse’s creditors or the surviving spouse’s mismanagement or substance abuse.
6. One reason often cited to rely on portability is the availability of a step-up in income tax basis at the death of the surviving spouse. However, a credit shelter trust could be drafted to get a step-up in basis on the assets to the extent the inclusion does not cause an estate tax. Thus, you could achieve the best of both worlds.

There are situations in which relying on portability makes sense and there are other situations in which relying on a credit shelter trust makes more sense. It’s important to use the right strategy for the client’s unique situation.

Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com