What's a Credit Shelter Trust? Portability?

The estate tax exemption amount is the amount that the federal government allows you to leave to your kids, grandkids, and people other than your spouse and charity without paying estate tax. In 2015, that amount is $5.43 million. The amount is indexed for inflation, so it goes up every year (unless the law changes, of course).

Let’s say George and Martha are married and have a few kids. Martha has $6 million, and George has $3 million.

Let’s assume George and Martha don't do any kind of estate planning. George dies. All of his property goes to Martha. No estate tax is due upon George's death, because the transfer to Martha qualifies for the estate tax marital deduction. So Martha has $9 million after George’s death. Let's assume Martha doesn't file an estate tax return upon George's death or do any kind of estate planning.

Let’s say Martha dies a few years after George. All of the remaining property passes to the couple’s children--after Martha’s estate pays some estate tax. Basically, the among in excess of Martha’s exemption will be subject to estate tax at a rate of 40%. In this situation, George’s estate tax exemption (his $5.43 million exemption) was wasted. With a little bit of planning, George and Martha could have made use of George’s exemption and Martha's, and avoided the estate tax.

Let's go back to immediately after George's death. Let's still assume George didn't have a will or trust, but assume Martha went to see an attorney.

The attorney might have advised Martha to “disclaim” (refuse to accept) all or a portion of the property George left to her. If she disclaimed $5.43 million, she’d have made full use of George’s estate tax exemption. That money would have gone to the couple’s children, and no estate tax would be due on that property upon Martha's death.

Disclaimers are convenient and afford considerable planning flexibility. But put yourself in Martha's shoes and consider whether you would make a disclaimer. Keep in mind that Martha would have to completely give up access to $5.43 million of the $6 million she received upon George's death.

Let’s say George’s estate plan (will or trust) contained a Credit Shelter Trust to hold the property Martha disclaimed. Instead of passing directly to the couple’s children as in the previous paragraph, the money Martha disclaimed would go into the Credit Shelter Trust. This trust would provide for Martha and the couple’s children. Since the trust also provides for Martha, she doesn’t have to completely give up George’s $5.43 million: she has some access to the money.

Side Note: Estate tax planning can be much more complicated than the scenario I’m describing. The spouse's share can be held in trust. Formulas and QTIP elections, rather than disclaimers, can drive the allocation between the Credit Shelter Trust and the spouse's share or trust.

Before 2011, using a Credit Shelter Trust or leaving assets to children (or other non-spouse beneficiaries) were the only ways to prevent George’s estate tax exemption for going to waste upon his death. Since 2011, we've had another option: portability.

Let’s assume again that George died without an estate plan, and Martha went to an attorney after his death. The attorney explained disclaimers, and Martha decided she did not want to make a disclaimer. If this had happened before 2011, George's estate tax exception would have been lost--the exemption was a "use it or lose it" exemption. Now, Martha, would have another option: she could elect or opt into portability by filing an estate tax return with the IRS. By filing that return, she gets to have George's unused estate tax exemption amount basically transferred to her.

George's unused estate tax exemption amount at his death is called the Deceased Spousal Unused Exclusion Amount or DSUE amount. George's DSUE amount might be less than $5.43 million, as he might have uses up some of it while he was alive by making large gifts; however, let's assume he didn't use any of it. That means the estate tax exemption available to Martha, if she were to die later this year, would be $10.86 million.

Portability is a great option for George and Martha, under the circumstances: it allows George's estate tax exemption to be used without necessitating that Martha give up access to George's money. However, had George and Martha planned their estates, they could have left themselves more options and possibly achieved an even better outcome.

Portability does have disadvantages. From a tax standpoint, George and Martha may behave been able to achieve a better outcome with additional planning. Also, the non-tax outcomes in this scenario might not be the same outcomes George and Martha would have chosen, had they considered more of the available options.