Portability and Pre-Marital Agreements: Who Gets the Benefit?

October 17, 2016

By C. Arthur Robinson, II

There is a unique interaction between estate taxation and family law which has arisen as a result of the portability election for estate taxes which was enacted several years ago.

Portability is the concept of allowing a surviving spouse to utilize the unused exemption of a deceased spouse. For example, in the current planning environment an individual’s lifetime exemption of $5,430,000 would not be utilized if that person’s estate was only $1,000,000. The $1,000,000 could pass to any party other than a spouse and leave behind unused exemption of $4,430,000, or the entire exemption amount if the $1,000,000 were allocated to the surviving spouse.

The ability to preserve this tax benefit, but only in the hands of the surviving spouse, has created a very interesting planning opportunity for domestic relations lawyers. Specifically, who gets to utilize this credit and under what circumstances can it be used.

First, it is important to understand that in a situation which there are blended families that very often children of a prior spouse are dealing with a surviving spouse of a parent with whom they may not have the friendliest of relationships. In that situation, trying to convince children of spouse #1 to allow spouse #2 to have a tax benefit (which could save millions of dollars in taxes), is something that could create significant and serious tension in a situation that already may be of significant concern for the members of the family.  In this situation, and especially in the case of blended families, where our clients are remarrying, it is important to consider whether a premarital agreement should address the issue of whether a surviving spouse might claim the portability election and the circumstances under which they may do so.

It is important to understand, in order for the portability election to be made, that an estate tax return must be filed for the deceased spouse even if there is no requirement to file such a return created by the size of the estate or potential tax thereon. In a situation where absent the possibility that a spouse might utilize the exemption, the estate is far below the filing threshold, normally the advice would be not to file the return. However, on our fact pattern, if the surviving spouse is an individual of significant wealth, it may be possible that the deceased spouse unused exemption will save the surviving spouses heirs perhaps millions of dollars. In that situation the premarital agreement should clearly identify how this issue should be dealt with.

A typical and balanced approach would be to have the executor, pursuant to the estate planning document and a premarital agreement, agree that an estate tax return would be filed, specifically and only for purposes of computing the deceased spouse unused exemption amount. In this instance, that would enable the surviving spouse to later utilize that unused exemption for variety of purposes. The expense of gathering information, preparing the return and otherwise providing for the return to be filed, should properly be borne by the party that benefits.  In some premarital agreements we have even seen contractual provisions that provide that some benefit will flow back to other family members as a result of allowing a surviving spouse to have available to them the deceased spouses unused exemption. 

Careful planning should be done and this issue should be decided well ahead of time so that an executor, who very often will be a child, or other family member, and who may or may not be on good terms with the surviving spouse, understands clearly what his or her duties and obligations are under the circumstances.  It is also both fair and reasonable to allocate the burden of the preparation of the estate tax return as well as any benefit that should flow to other family members as a result of the surviving spouses being able to utilize this amount.  All such details should be clearly laid out in the premarital agreement. If this is properly done then it is very easy to reference the premarital agreement and provide for executors and trustees to follow the agreements made therein.   This eliminates both substantial uncertainty as well as preventing a conflict which could otherwise arise as a result of the utilization of a credit which is unused by the first spouse to die.

We at Wolcott Rivers Gates are familiar with these issues and can assist you at evaluating and reaching an appropriate decision about how portability should be handled, especially for blended families.