As mentioned in an earlier blog, ATRA made two elements of the law in effect for 2011 and 2012 “permanent:” (i) portability, and (ii) the $5 million federal tax threshold amount, indexed.   The indexing results in an effective threshold of $5.25 million for federal estate tax purposes this year.

For Marylanders, however, the state estate tax remains at a threshold of $1 million.   Therefore, if a married couple with more than $1 million but less than approximately $10 million fails to provide for a credit shelter trust to “capture” the $1 million free-ride for state purposes, an additional state tax will be triggered at the second death.   [For Marylanders with approximately $2 million of asset value the additional tax is about $100,000 but for wealthier persons this amount and the tax rate will climb.]

The federal system, however, may no longer require the creation of a credit shelter trust at the first death through portability, which permits the surviving spouse to use both his or her credit amount and that of his or her deceased spouse.   This means that couples with $10 million can pass that on to the next generation with little or no tax planning assuming portability is preserved.   Portability is preserved by filing a timely federal estate tax return (form 706) for the first estate.   Although the requirements for this return are more relaxed than for that of a full-blown 706, it still is a requirement.   Such return for Marylanders is required in any event for state estate tax purposes.

Assuming that the couple would not have a federal estate tax, is a credit shelter trust needed or desirable any longer for any reason other than to preserve the Maryland estate tax amount?   The answer is an unambiguous “maybe.”   Having a credit shelter trust after the first death does, obviously, introduce some complexity to the survivor’s life which may not be necessary anymore due to portability

However, reasons why clients may want to keep the traditional pattern which involves a credit shelter trust for both state and federal purposes include the following:

Asset Protection.   The credit shelter trust can be designed to protect those assets from the creditors of the surviving spouse.   This protection would not just be from persons suing the surviving spouse but also from claims against those assets triggered by a subsequent marriage and such a trust would preserve at least part of the couple’s assets for the children.

Hedging Future Tax Law Change.   Although ATRA is “permanent” that does not mean it cannot be changed by future Congresses.   By locking in the tax benefit at the first death, those assets are taken off the table in calculating the tax for the second death.

Protecting State Tax Savings.   As mentioned above, of course, the Maryland estate tax is saved by the credit shelter tax to at least pick up the threshold amount of Maryland ($1 million).

Remove Appreciation From Tax.   Portability works at the second death.   The credit shelter would be funded with assets at the first death and any appreciation on those assets would not be exposed to a later tax.   In times of high inflation this would be a great benefit to lock in those assets from any further exposure from the federal estate tax.   The flip side, however, is that those assets would not enjoy a stepped up basis at the second death thus potentially exposing the sale of the assets to capital gains tax.   Today the highest capital gains tax is approximately equal to the flat estate tax rate.   Thus there may not be any arbitrage in the rates.   The estate tax, however, is due regardless of whether an asset is sold whereas the capital gains tax would be due only when an asset is sold and presumably there are funds to pay the tax.

As always, protecting assets from various predators, whether the predator is the IRS, the Comptroller of the State of Maryland, or more garden variety opportunists, protecting assets takes planning and forethought.