Although there is now a generous federal estate tax exemption, there are still state estate taxes. You’ll want to make informed decisions about how to pass your wealth to your surviving spouse. Trusts may be a good option, but there are different paths you can take to arrive at the same destination: minimizing or eliminating any estate tax.
There are ways to have estate tax exempt wealth be transferred on death to a surviving spouse without the use of a trust, but as noted in a recent article in Barron’s, “How to Protect Your Estate-Tax Exemption, the bottom line is that what we consider federally exempt wealth remains subject to the estate tax laws of individuals states. Many wealthy people rely on credit shelter trusts to protect assets that would otherwise be exempt from federal estate taxes, minus gifts made during your lifetime. A relatively recent development, known as “portability” gives you some ability to transfer wealth on death, but these are sophisticated tools that will require the help of an experienced estate attorney.
An option between portability and credit-shelter trusts—or a combination—is still a critical component of estate planning, despite the federal estate-tax exclusion dramatically increasing over the years. Twenty years ago, it was an easier decision: in 1997, the estate-tax exemption was only $600,000 and the top estate-tax rate was 55%. Credit-shelter trusts were popular to avoid some onerous taxes. The exemption then began to creep up to the current $11 million for a couple. In 2012, Congress enacted portability to remove the need for credit-shelter trusts for married couples.
Some experts say that a credit-shelter trust is better than portability, even for couples below the $11 million level. However, portability doesn’t exempt state estate taxes. There are 18 states and DC that have either estate or inheritance taxes of various amounts and rates. There’s also no generation-skipping with portability. The surviving spouse can’t take the $5.49 million estate-tax exemption she got via portability, and place it in a tax-free trust for her grandchildren. She also can’t protect appreciating assets from capital gains. Portability won’t protect the assets of a new spouse if the surviving spouse remarries or from stepchildren.
Credit-shelter trusts also have some cautions. If you place a primary residence in a trust, there will be mortgage problems because banks don’t want to lend money to a trust. A house in a trust doesn’t get a further stepped-up value after the surviving spouse dies. Therefore, if the children want to sell the house, they may have a sizeable capital gains tax on the difference in value between the two deaths.
If you live in a state with an estate tax, you may want to ask your estate planning attorney about putting the amount of the state tax exemption in the credit-shelter trust and elect portability for the balance of the estate up to the $5.49 million.
There are still many unknowns about possible changes to the estate tax exclusion, including the possibility of a change to the capital gains rate. Rather than wait to see what happens and potentially lose the ability to benefit from tax laws as they currently stand, speak with an estate planning attorney. She or he will be able to work with you to determine how to structure your assets to minimize tax liability and to protect your family.
Reference: Barron’s (March 25, 2017) “How to Protect Your Estate-Tax Exemption”