Updated Tuesday, July 29, 2014 as of 4:43 AM ET
Estate Planning Beyond the $10.68M Exclusion
by: Donald Jay Korn
Monday, March 10, 2014
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Between portability and a plump exemption, few clients have to worry about federal estate tax, at least for now.

Nevertheless, wealthy individuals and families still can benefit from such planning. “We continue to use traditional vehicles such as marital trusts and credit shelter trusts, especially for high-net-worth clients,” says Donna Barwick, Atlanta-based vice president in the wealth advisory group of Wilmington Trust.

Currently, the federal estate tax exemption is $5.34 million, which will be indexed for future inflation. With portability, a married couple can shelter up to $10.68 million with little planning.

‘DSUEA’

Barwick uses the expression DSUEA (pronounced d’sue-ah), which stands for the “deceased spouse’s unused exclusion amount,” to illustrate the concept.

Say Al Smith dies in 2014 and leaves his entire estate to his wife Beth (a U.S. citizen). Assuming Al never made any taxable gifts, he has not used any of his estate tax exemption so his DSUEA is $5.34 million. If Al’s executor elects portability on a federal estate tax return, his DSUEA transfers to Beth. Thus, if Beth makes no taxable gifts and subsequently dies in a year with a $6 million exemption, she will be able to leave up to $11.34 million (her $6 million exemption plus the $5.34 million DSUEA from Al) to her children or nieces or friends from down the block, exempt from federal estate tax.

As generous as that may sound, portability doesn’t completely cover HNW clients who expect estates to top $10.68 million ($5.34 for unmarried individuals), adjusted for future inflation. The federal estate tax rate is 40%, so $400,000 out of every $1 million over the limit will go to Uncle Sam. Such taxes could pose liquidity issues for a family business, say, or extensive real estate holdings, so advisors with HNW clients should prepare a plan that goes beyond depending on DSUEA.

TRUST PLANNING

As Barwick mentions, traditional trust planning can be considered. A marital trust (“A” trust) generally can hold assets left for the benefit of a surviving spouse, estate tax-free, with no dollar limit. A credit shelter trust (“B” or bypass trust) can hold amounts up to the prevailing exemption amount, untaxed at the death of either spouse.

“Some plans call for the executor of the first spouse to die to be able to make a partial ‘QTIP’ election for some assets,” says Barwick.  Those assets will go into a QTIP trust – a Qualified Terminable Interest Property trust – which is a marital trust that limits the surviving spouse’s access to the trust assets. A QTIP trust can qualifiy for the unlimited marital exemption from estate tax and provides for the surviving spouse. The remaining assets in that trust eventually can go to beneficiaries named by the decedent, such as children from a previous marriage.

PORTABILITY DRAWBACKS

Estate planning for HNW clients also should recognize some drawbacks to portability. “The DSUEA is not indexed for inflation,” Barwick points out. “In addition, you can only use the DSUEA that was ported from the last spouse to predecease you.” Thus, if Beth Smith in the above example marries Craig Jones after Al’s death, and Craig also leaves Beth a widow, Beth can use the DSUEA from Craig but not from Al. In some situations, there could be a loss of tax shelter.

“One possible solution,” says Barwick, “is to deploy the ported amount.” The DSUEA can be used for gift tax as well as estate tax purposes. Consequently, Al’s $5.34 million DSUEA likely will be available for Beth to give away to her children or other recipients, free of gift tax, any time before Craig’s death.  Beth can get assets out of her estate, along with future growth, and eventually use Craig’s DSUEA as well, provided she is a serial survivor.

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