Portability & Estate Tax Considerations with Trusts

Estate planning involves strategic tools to protect assets, minimize taxes, and ensure wealth is efficiently transferred to beneficiaries. One critical aspect of estate planning is understanding portability and estate tax considerations when using trusts. Proper planning can help married couples maximize their estate tax exemption and preserve wealth for future generations.

If you're considering trusts in your estate plan, an estate planning attorney can help you navigate complex tax laws. Contact us online or call 414-253-8500 to discuss your options.

What Is Portability in Estate Planning?

Portability is a federal estate tax provision that allows a surviving spouse to inherit the unused portion of their deceased spouse's federal estate tax exemption. This means that if the first spouse to die does not use their full exemption amount, the remainder can be transferred to the surviving spouse, effectively increasing their exemption.

Key Aspects of Portability:

• Only Available to Married Couples - Portability applies only to legally married spouses under federal law.
• Must Be Elected - The executor of the deceased spouse's estate must file an estate tax return (Form 706) to claim portability.
• Does Not Apply to State Estate Taxes - Some states impose their own estate tax without portability, which may require additional planning.
• Can Be Lost If Not Claimed Timely - If the estate tax return is not filed within five years of the first spouse's death (or the IRS deadline), portability may be lost.

Benefits of Portability:

• Increases the surviving spouse's estate tax exemption, reducing potential tax liability.
• Simplifies estate planning for high-net-worth couples.
• Helps avoid the need for complex trust structures in some cases.

Understanding the Federal Estate Tax Exemption

The federal estate tax exemption allows individuals to transfer a certain amount of wealth without incurring estate tax. For 2024, the exemption is $13.61 million per individual (subject to inflation adjustments). This means a married couple could shield up to $27.22 million from estate taxes with proper planning.

Estate Tax Rates

If an estate exceeds the exemption amount, the excess is subject to the federal estate tax, which ranges from 18% to 40% depending on the taxable amount. Proper trust planning can help reduce or eliminate estate tax liability.

How Trusts Impact Portability and Estate Taxes

Trusts are essential tools for estate tax planning, asset protection, and ensuring wealth is managed according to your wishes. While portability allows spouses to transfer exemptions, trusts provide additional flexibility and control over asset distribution.

Types of Trusts Used in Estate Tax Planning

1. Credit Shelter Trust (Bypass Trust)

   • Preserves the deceased spouse's estate tax exemption without relying on portability.
   • Assets placed in the trust are not included in the surviving spouse's estate, reducing future tax liability.
   • Beneficiaries (typically children or other heirs) receive tax-efficient inheritances.

2. Marital Trust (QTIP Trust - Qualified Terminable Interest Property Trust)

   • Provides for the surviving spouse while controlling the eventual distribution of assets to beneficiaries.
   • Delays estate taxes until the surviving spouse's death.
   • Useful in blended families to ensure assets pass to designated heirs.

3. Revocable Living Trust

   • Avoids probate but does not provide estate tax savings on its own.
   • Can be structured with tax-planning provisions to maximize portability and exemptions.
   • Provides incapacity protection by appointing a successor trustee.

4. Irrevocable Life Insurance Trust (ILIT)

   • Removes life insurance proceeds from the taxable estate.
   • Ensures beneficiaries receive life insurance free from estate taxes.
   • Provides liquidity for estate taxes, debts, or family needs.

5. Charitable Trusts (CRT or CLT)

   • Reduces taxable estate by gifting assets to charity.
   • Can provide income to the donor or beneficiaries before benefiting charity.

Trusts and portability can work together to create an effective estate tax strategy. The next section explores the advantages and limitations of using portability compared to trusts.

Portability vs. Trusts: Which Strategy is Best?

Both portability and trusts offer ways to minimize estate tax liability, but they serve different purposes. While portability allows a surviving spouse to take advantage of unused federal exemptions, trusts provide more control, asset protection, and potential tax benefits.

Advantages of Portability

• Simple and straightforward - No need for complex trust structures.
• Preserves the deceased spouse's exemption - Ensures up to double the estate tax exemption for married couples.
• Avoids immediate estate tax payments - Helps delay or eliminate estate tax obligations for the surviving spouse.

Limitations of Portability

• No protection from creditors - Assets passed via portability remain part of the surviving spouse's estate and are subject to lawsuits or creditors.
• Does not apply to state estate taxes - Some states have their own estate tax with lower exemptions and no portability provision.
• Requires proper tax filing - If Form 706 is not filed timely, the portability benefit is lost.
• No control over asset distribution - If the surviving spouse remarries or has financial difficulties, inherited assets may not go to the intended beneficiaries.

Advantages of Trusts

• Protects assets from creditors - Assets in irrevocable trusts are shielded from lawsuits and financial risks.
• Reduces taxable estate - Certain trusts remove assets from the estate, lowering estate tax exposure.
• Provides control over asset distribution - Beneficiaries receive funds according to your wishes, even after the surviving spouse's passing.
• Can address state estate taxes - Trusts can help mitigate state-level estate taxes where portability does not apply.

Limitations of Trusts

• More complex setup - Requires legal documentation and planning.
• May require ongoing administration - Trustees must manage the trust and comply with fiduciary duties.
• Irrevocable trusts limit access - Once assets are placed in an irrevocable trust, they generally cannot be reclaimed by the grantor.

When to Use Portability, Trusts, or Both?

Estate Planning Scenario	Best Strategy
Married couple with a net worth under the federal estate tax exemption	Portability alone may be sufficient
High-net-worth couple seeking tax efficiency and asset protection	Combination of trusts and portability
Concern about remarriage or protecting children's inheritance	Trusts (e.g., bypass trust, QTIP trust)
Business owners or individuals with high-value life insurance	Irrevocable Life Insurance Trust (ILIT)
State estate taxes are a concern	Trusts to minimize state-level estate tax impact

A comprehensive estate plan often combines portability and trusts to maximize tax savings while ensuring asset protection and controlled distribution.

Estate Tax Planning Strategies Using Portability and Trusts

1. Portability with a Disclaimer Trust

A disclaimer trust allows the surviving spouse to decide how much of the deceased spouse's exemption to use. If estate tax laws change or the surviving spouse does not need the assets immediately, they can disclaim them into a trust, preserving the exemption while maintaining flexibility.

2. Portability with a Credit Shelter Trust

A credit shelter trust (also called a bypass trust) ensures that the first spouse's exemption is used effectively. Instead of relying solely on portability, the trust keeps assets out of the surviving spouse's estate while still allowing income benefits.

3. Generation-Skipping Transfer (GST) Tax Planning

Portability does not apply to the generation-skipping transfer (GST) tax exemption, which protects assets passed to grandchildren from additional taxation. Trusts are essential for GST tax planning, allowing wealth to pass efficiently across multiple generations.

Key Takeaways on Portability and Trusts

• Portability allows spouses to transfer unused estate tax exemptions, but it does not provide asset protection or control over future distribution.
• Trusts offer greater flexibility, protection, and long-term tax benefits, particularly for high-net-worth families.
• A combined approach using portability and trusts often provides the most effective estate tax strategy.
• Proper estate tax planning requires timely action, including filing the appropriate tax forms and structuring trusts correctly.

Contact an Estate Planning Attorney for Trust and Tax Guidance

Understanding the nuances of portability, estate taxes, and trusts can be complex, but the right estate plan can save your family millions in taxes and provide long-term financial security. Whether you need help structuring a trust, maximizing your exemptions, or ensuring your estate plan is tax-efficient, we can help.

Contact us online or call 414-253-8500 to schedule a consultation with an experienced estate planning attorney today.

Frequently Asked Questions (FAQs)

1. What is portability in estate tax planning?

Portability allows a surviving spouse to inherit and use the unused portion of their deceased spouse's federal estate tax exemption. This means if the first spouse to pass away does not use their full exemption, the remainder can be added to the surviving spouse's exemption, reducing future estate taxes. However, portability does not apply to state estate taxes or generation-skipping transfer (GST) taxes.

2. Does portability eliminate the need for trusts in estate planning?

No, while portability helps reduce estate tax liability, it does not provide the asset protection and control that trusts offer. Trusts ensure assets are distributed according to your wishes, shield assets from creditors, and can help mitigate state estate taxes, which portability does not address. A combination of portability and trusts is often the best approach.

3. What happens if I don't elect portability after my spouse's death?

If portability is not elected by filing IRS Form 706 within five years (or the IRS deadline), the unused exemption from the deceased spouse is lost. This means the surviving spouse will only have their own individual estate tax exemption and may face higher estate taxes. Consulting an estate planning attorney can help ensure you don't miss this crucial step.

4. Can portability be used with irrevocable trusts?

Yes, portability can be used alongside irrevocable trusts like credit shelter trusts (bypass trusts) or irrevocable life insurance trusts (ILITs). These trusts provide additional estate tax savings, asset protection, and control over distributions while still benefiting from the portability election.

5. How do trusts help reduce estate taxes compared to portability alone?

Trusts help minimize estate taxes by removing assets from the taxable estate, which can reduce or eliminate the tax burden for future generations. Unlike portability, which only transfers exemptions between spouses, trusts can:

• Shield assets from creditors and lawsuits
• Allow wealth to pass tax-efficiently to children and grandchildren
• Reduce state estate tax liability
• Provide structured distributions for beneficiaries

If you're considering trusts or portability in your estate plan, speaking with a knowledgeable estate planning attorney can help you determine the best strategy for your situation.