Every U.S. citizen may gift, during life or at death, assets to his or her children free of federal estate or gift tax up to an aggregate
amount – frequently called the “exemption amount.” The exemption amount in 2021 is $11.7 million.

Prior to 2011, if one spouse died without having gifted or bequeathed all of his or her exemption amounts to a non-spouse, any unused exemption was lost, i.e., use it or lose it. The federal estate tax law was amended, effective January 1, 2011, to permit the first spouse to die to “give” any unused federal exemption amount to the surviving spouse. This is called “portability.” The executor makes the portability election by filing a federal estate tax return for the first spouse to die. Thanks to “estate tax portability,” the unused portion is added, dollar for dollar, to the surviving spouse’s exemption amount to apply to future transfers to descendants.

Prior to 2011, to protect against the loss of unused exemptions, many wills included “exemption trusts” for the benefit of one’s spouse and children in an amount equal to the unused exemption. The exemption trust does not qualify for the estate tax marital deduction. While exemption trust assets are still available for the use of the surviving spouse, they are not included in the surviving spouse’s estate (no matter how large they grow) and can pass to descendants free of the estate tax. The surviving spouse can then use his or her own exemption amount on additional assets that can pass to descendants free of gift and/or estate tax.

With portability, is it still necessary to have an exemption trust? It depends, and each person should consider his or her particular circumstances carefully before deciding whether or not to rely on portability and forego the opportunity to create an exemption trust. Circumstances to consider include the fact that New York does not permit portability for the NYS exemption amount ($5.93 million for 2021) and the income tax basis of the assets used to fund the trust.

A simple “compromise” is to create what is known as a “disclaimer” trust in the will of each spouse. With a disclaimer trust, everything passes outright to the surviving spouse, except to the extent the surviving spouse disclaims (i.e., says he or she does not want assets outright). The disclaimed assets are then held in a disclaimer trust. The disclaimer trust gives the surviving spouse the maximum flexibility to decide, after considering all circumstances at the time of his or her spouse’s death, whether to fund the disclaimer/exemption trust or rely partly or wholly
on portability.

Originally published in Lloyd Harbor Life, November 2021.