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Martin_Shenkman
  Steve Akers
Martin Shenkman   Steve Akers
If Henry VIII Had Portability

Which spouse would come first?

September 6, 2011
by Martin Shenkman, CPA, PFS and Steve Akers, JD

Evaluating the Portability Options

This seems a bit like Goldilocks and the three bears trying to figure out which porridge is just right.

  • Porridge No. 1: If the estate of the surviving spouse is less than the aggregate of the surviving spouse’s exclusion as inflation indexed plus the first-to-die spouse’s non-inflation indexed exclu­sion, it would be advantageous from purely a federal tax perspective to use the outright bequest to the surviving spouse. This would provide the maximum basis step-up on second death for all assets and avoid any federal estate tax cost (ignoring state estate tax issues, protections afforded by trusts, and so on). In this scenario, the bypass trust porridge would be too hot.
  • Porridge No. 2: If the assets that could have been bequeathed to a bypass trust on the first death appreciate at a rate such that the aggregate of the bypass-able assets and the surviving spouse’s as­sets would exceed the first-to-die spouse’s exclusion (applied to the bypass trust) and the survivor’s exclusion, then it would be advantageous to fund the bypass trust to remove that excess apprecia­tion from the surviving spouse’s estate and avoid the estate tax on the second spouse’s death. In this scenario, the bypass trust porridge would be just right.
  • Porridge No. 3: Because the estate tax rate is now only 35 percent if the surviving spouse resided in a state with no estate tax but with a high income tax rate, when combined with the federal in­come tax rate applicable on the surviving spouse’s death exceeded the estate tax on the portion of the estate that exceeded the available estate tax exemption, the second basis step-up might be more valuable in terms of income tax savings than the savings in estate tax afforded by the bypass trust. In this scenario, the bypass trust porridge would be too cold.

The decision about whether to fund a bypass trust, with the complexities just described, will have to be made without the benefit of hindsight. Thus, the determination about which assets might fund the bypass trust, the life expectancy of the surviving spouse, the likelihood of the surviving spouse remarry­ing a new spouse who dies before the surviving spouse, the appreciation potential of the assets used to fund the bypass trust, the inflation increase in the surviving spouse’s exclusion, and many more consid­erations will have to be evaluated to make the optimal decision. But in many instances, instead of going through this analysis, the use of appropriate trusts on the death of the first spouse will probably prove the safer bet and well worth the cost involved. Similarly, non-married partners will likely find trusts the way to go.

Which Spouse Is on First

The TRA’s portability provision is effective for estates of decedents dying after December 31, 2010.

TRA Section 303(a) provides:

(4) Deceased Spousal Unused Exclusion Amount. — For purposes of this subsection, with respect to a surviving spouse of a deceased spouse dying after December 31, 2010, the term “deceased spousal unused exclusion amount” means the lesser of — (A) the basic exclusion amount or (B) the excess of — (i) the basic exclusion amount of the last such deceased spouse of such surviving spouse, over (ii) the amount with respect to which the tentative tax is deter­mined under section 2001(b)(1) on the estate of such deceased spouse.

The phrase “basic exclusion amount of the last such deceased spouse” implies that the first-to-die spouse’s exclusion is not inflation adjusted as suggested earlier. Furthermore, the phrase “last such deceased spouse” has a special impact (different from previous portability legislative proposals). The phrase implies that if Husband 1 is married to Wife 1 and Husband 1 dies, Wife 1 would be able to uti­lize Husband 1’s remaining exclusion. However, what if Wife 1 remarries Husband 2? Would Wife 1’s estate only be entitled to utilize the remaining exclusion from Husband 2? Although remarriage might be viewed as reasonably cutting off the right to use the prior spouse’s exclusion, this does not appear to be the manner in which the law operates.

Thus, this new law provides that the unused exemption is only available from the “last such de­ceased spouse.” This means that if the surviving Wife 1 remarries Husband 2, she may still use the unused exemption from Husband 1 because Husband 1 still remains her “last deceased spouse” so long as Husband 2 is alive. When Husband 2 dies, then Wife 1 could only use Husband 2’s unused exemption (if any), and Wife 1 could no longer use Husband 1’s unused exemption. Although it seems somewhat odd that being married to a new spouse with a new exemption would still mandate the use of the last spouse’s exemption that seems to be the case.

Portability and Prenuptial Agreements

Might Internet marriage want ads soon tout exclusion availability? “Handsome and pleasant male age 89 available for marriage. No assets, but full estate exclusion portable and available. Corroboration from major law firm available for review.”

Should premarital due diligence include a review of all prior gift tax returns to ascertain if the ad­equate disclosure rules were met and the statute indeed tolled? If the items reported on a gift tax return were reported with sufficient specificity and disclosures, then the period during which the IRS can audit that return will run out (toll). When the audit period has expired, the IRS cannot revisit the returns and audit them. Thus, just as on American Idol, you may be “safe.”

Perhaps for open gift tax return years (that is, returns for periods that the IRS can still audit the re­turns), the prenuptial agreement should provide a readjustment of the negotiated financial arrangements if the audit of those returns depletes the remaining exclusion of the spouse being represented.

Matrimonial counsel should also carefully evaluate having an estate planner transfer assets to an ir­revocable trust for the client prior to marriage. Because it appears that portability of estate exclusion can be applied to intervivos gifts by the surviving spouse as well, this may secure the benefit of that exclu­sion without the risks discussed previously. This may not be a simple task if the surviving spouse has to use her own exclusion (basic exclusion amount) first, or simultaneously.

If Henry VIII Had Portability

The wives of Henry VIII, in order, were: Catherine of Aragon, Anne Boleyn, Jane Seymour, Anne of Cleves, Catherine Howard and Catherine Parr.

The famous rhyme tells what befell each of the above wives. The analysis indicating impact on por­tability was actually developed in more recent times.

Divorced beheaded died
Divorced beheaded survived.

  • Catherine of Aragon was divorced, so Henry VIII obtained no benefit of her unused exclusion. Portability scorecard -0-.
  • Anne Boleyn was beheaded so presumably, but for potential application of the slayer statute, Henry VIII could have benefited from her unused exclusion. But because he later married Jane Seymour, who died, he would have had to have used Anne Boleyn’s exclusion for gift purposes before Jane died; it would no longer have been available at his death. Portability scorecard $5M.
  • Jane Seymour died. So her death cut off Henry VIII’s use of Anne Boleyn’s exclusion, but being a wily kinda guy, we’ll assume he used it for gift purposes. Portability scorecard $10M.
  • Anne of Cleves divorced Henry, so Henry VIII obtained no benefit of her unused exclusion. Porta­bility scorecard stays at $10M.
  • Catherine Howard was beheaded so presumably, but for potential application of the slayer statute, Henry VIII could have benefited from her unused exclusion. But because his prior deceased spouse Jane Seymour had died, we will continue to assume that he used Jane Seymour’s exclusion for gift purposes. So Catherine Howard should become the last deceased spouse. Portability scorecard $15M.
  • Catherine Parr appears to have survived (or the old rhyme ended before her) so that Catherine Howard remains the last predeceased spouse. But Catherine Parr has her own exclusion that she could use before death so that effectively Henry VIII’s portability scorecard can count her $5M for the family fisc. Portability scorecard $20M.

For homework, please analyze Herman’s Hermits song from a portability perspective:

I’m Henry the eighth I am
Henry the eighth I am, I am
I got married to the widow next door
She’s been married seven times before …

This article has been excerpted from Estate Planning After the Tax Relief and Job Creation Act of 2010: Tools, Tips and Tactics. You can purchase the book at www.cpa2biz.com.

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Martin M. Shenkman, CPA, MBA, PFS, AEP, JD, is an attorney in New Jersey and New York City. His practice concentrates on estate and closely held business planning, tax planning and estate administration. Steve R. Akers, JD, is an attorney with 33 years of experience in estate planning and probate law matters. He is a managing director at Bessemer Trust. Editor Note: The authors are donating 100 percent of the royalties from this book’s sales to the following three foundations: Michael J. Fox Foundation for Parkinson’s Research, National Multiple Sclerosis Society and the Association of Hole in the Wall Camps.

* The AICPA’s Personal Financial Planning Section is the premier provider of information, tools, advocacy and guidance for CPAs who specialize in providing estate, tax, retirement, risk management and investment planning advice to individuals and closely held entities. The Personal Financial Planning Section is open to all Regular Members, Associate Members and Non-CPA Section Associate Members of the AICPA. If you are a CPA who wants to demonstrate your expertise in this subject matter, become a Personal Financial Specialist Credential holder. Visit www.aicpa.org/PFP to learn more.