Portability versus credit shelter trusts
By Julius Giarmarco
Giarmarco, Mullins & Horton, P.C.
The decision on whether to use a credit shelter trust or to rely on portability will depend on each couple’s facts and circumstances. But when in doubt, prudence dictates opting for a credit shelter trust.
The Taxpayer Relief Act of 2012 has made portability permanent. Portability effectively makes the federal estate tax exemption (presently $5.25 million, indexed for inflation) “portable” between spouses. Therefore, when one spouse dies, the surviving spouse can use the deceased spouse’s unused estate tax exemption amount without having to set up a credit shelter trust.
There are several reasons why planners may decide to rely on portability instead of creating credit shelter trusts. Situations favoring an approach leaving all of the assets outright to the surviving spouse, or to a trust for the benefit of the spouse with no restrictions (in order to avoid probate), include:
1. To obtain a stepped-up basis at each spouse’s death. The assets held in a credit shelter trust (from the date of the first spouse’s death to the date of the surviving spouse’s death) do not receive a stepped-up basis.
2. The credit shelter trust would have to be funded with qualified plan and IRA benefits. This would prevent a spousal rollover, and “flipping” to the children's/grandchildren’s life expectancy at the surviving spouse’s death. Thus, the ability to “stretch” the retirement plan benefits over the longest time period is lost with a credit shelter trust.
3. Creditor protection and property management for the surviving spouse is not a concern.
4. A first marriage or no children from a prior marriage.
5. The appeal of not having to re-title assets (currently in joint name) into separate trusts.
Another advantage of not using a credit shelter trust is the fact that a trust reaches the highest income tax rate of 43.4 percent at $11,950 compared to $400,000 for single taxpayers and $450,000 for married taxpayers (for 2013). Despite the simplicity of portability (particularly for smaller estates), situations favoring the use of a credit shelter trust include:
1. Avoiding (or minimizing) inequities in blended families, restricting transfers of assets by the surviving spouse, providing management and asset protection.
2. The estate tax exemption “inherited” from the deceased spouse is not indexed for inflation (as is the surviving spouse’s own estate tax exemption).
3. The appreciation in assets held by a credit shelter trust is excluded from the surviving spouse’s gross estate.
4. There is no portability of the first deceased spouse’s generation skipping tax exemption.
5. The exemption “inherited” from the deceased spouse may be lost if the surviving
spouse remarries and survives his/her next spouse.
6. The statute of limitations runs on estate tax values if a credit shelter trust is funded at the first spouse’s death. Closely related is that the credit shelter trust could be funded with discounted hard-to-value assets when there may be a low audit risk at the first spouse’s death.
7. To date, none of the states (or District of Columbia) that have their own death tax has made the state death tax exemption portable. Thus, married couples living in these states may want to use credit shelter trusts to take advantage of both spouses’ state death tax exemptions.
In summary, it is advisable that spouses have their estate plans reviewed to determine if it is necessary to establish a credit shelter trust at the first spouse’s death. If a credit shelter trust is not necessary, the estate plan should be redrawn to eliminate the credit shelter trust along with the expense of administering the trust for the lifetime of the surviving spouse.
As discussed above, the decision on whether to use a credit shelter trust or to rely on portability will depend on each couple’s facts and circumstances. But when in doubt, or on the fence, prudence dictates opting for a credit shelter trust.