If you want your estate plan to provide for a spouse or partner, you may be interested in some of the strategies discussed in this section. Consider these strategies under certain circumstances:

  1. Trust planning for unmarried partners, couples in a civil union, or couples in a registered domestic partnership
  2. Trust planning for married couples
    • Credit shelter trust and "portability"
    • Qualified Terminable Interest Property Trust (QTIP Trust)

Keep in mind the examples used in this section focus on federal estate tax law. Several states have state-specific estate taxes that may impact your estate plan. Address state-specific tax issues with your tax and legal advisors to determine if additional planning is needed.

Trusts can also be used to provide for an unmarried partner. It is important to keep in mind, the $5,450,000 applicable exclusion is a powerful tool that couples can use to avoid or reduce federal estate tax.

Under current law, there is no federal estate tax for an ummarried couple whose combined estate is below the applicable exclusion amount.

Consider this example, Ted has an estate of $1 million, and Neil has an estate of $1.2 million.

If Ted dies and leaves everything to Neil, there is no federal estate tax, because Ted's estate is below the $5,450,000 applicable exclusion. No marital deduction is available because they are not married. But the applicable exclusion is large enough to protect Ted's entire estate from federal estate tax.

Neil now has an estate of $2.2 million. When Neil dies, there is again no federal estate tax, because Neil's estate is below the applicable exclusion.

Keep in mind that the federal applicable exclusion is indexed to inflation and therefore likely to change after 2016. Also, some states impose their own estate or inheritance taxes, which could begin at a lower threshold. So it's important to work with a qualified tax advisor who knows the rules that apply in your state, and can help you keep up to date on changing laws.

For unmarried couples, providing continuing financial security for a partner is often a primary concern. But you should also think about what you would like to happen to your assets after the surviving partner dies. For example, let's say that Ted has a close relationship with his brother and also has a sister with special needs. Instead of leaving assets outright to Neil, Ted could direct that some or all of his assets will go to a trust. The trust will pay all of its income to Neil, and can make principal available to Neil if needed. But the trust could also provide that after Neil's death, any remaining trust assets will be distributed to Ted's brother, and to a special needs trust for Ted's sister.

So what happens when an unmarried couple's combined estate is greater than the exclusion?

In this example, Chloe has a taxable estate of $5 million, and Maria has $4 million. They are not married.

If Chloe dies and simply leaves everything directly to Maria, there is no estate tax at the first death, because Chloe's estate is less than the $5,450,000 exclusion. However, all of the assets become part of the surviving partner's taxable estate. The survivor is now faced with an estate tax based on the couple's combined assets – but with only one applicable exclusion available.

In this example, the surviving partner is left with $9 million. In 2016, this results in an estate tax of $1,420,000, leaving beneficiaries with $7,580,000 of the $9,000,000 total estate.

Example of surviving partner left with $9 million

Every couple's financial situation is unique, so it's important to work closely with your own attorney and CPA to determine what is best in your situation. But for financially successful unmarried couples, it is generally a good guiding principle to create an estate plan that will take advantage of both available exclusions, to the extent reasonably possible. Let's take a look at how that might work.

Here's an example of how, even for unmarried couples, trust planning can be used to take advantage of the exclusions available to both partners:

At the first death, instead of leaving assets directly to a survivor, a trust can be funded. In 2016, up to $5,450,000 can be transferred free of estate tax. (If the deceased individual's estate is greater than $5,450,000, the excess would be subject to federal estate tax at the first death.)

The trust can be designed to give the surviving partner a lifetime income. You can also give the surviving partner access to principal from the trust according to standards that you set.

This trust not only helps provide for the financial security of a surviving partner, but also can be designed so that trust assets will not be included in the surviving partner's taxable estate. This helps to reduce estate taxes on the couple's combined assets when the surviving partner dies.

The surviving partner still has his or her own applicable exclusion of $5,450,000 available to reduce overall estate taxes at the second death. In this example, the estate tax at the second death is zero, since the surviving partner's estate is lower than the federal applicable exclusion.

Keep in mind that the examples used in this section are focused on federal estate tax law. Several states have their own estate taxes that may impact your estate plan. This can get complicated, so be sure to address state-specific issues with your tax and legal advisors to determine if additional planning is needed in your situation.

The following sections on “Credit Shelter Trust Planning,” “Portability” and the “QTIP Marital Trust” describe federal tax concepts that apply to married couples. Be sure to work with a local attorney who can help you navigate both federal and state tax rules.

Credit shelter trust planning

A credit shelter trust is a technique that helps married couples whose taxable estate exceeds $5,450,000 in 2016 and assures that both available exclusions are used.

This type of trust offers three main benefits:

  • It protects the applicable exclusion of the first spouse to die.
  • It can provide funds to the surviving spouse during his or her lifetime.
  • It allows assets in the trust to bypass the surviving spouse's taxable estate.

Let's look at how a credit shelter trust can benefit your estate plan.

A married couple can provide for a credit shelter trust in their will or revocable living trust. The purpose of this technique is to take advantage of both spouses' respective estate tax exclusions. Here's how it works (see graphic below)

Let's assume that the first spouse dies in 2016 when the applicable exclusion amount is $5,450,000.

When the first spouse dies, an amount up to the estate tax exclusion, currently $5,450,000, is transferred to the credit shelter trust. In some cases, an individual may have an exclusion greater than $5,450,000. This can happen if the individual received additional exclusion amounts from a previously deceased spouse, if a "portability" election was made. No taxes are due on this amount because of the first spouse's applicable exclusion. The remainder of the estate passes to the surviving spouse with no taxes due because of the unlimited marital deduction.

The surviving spouse can receive a lifetime income from the trust. You can also give the surviving spouse access to the principal from the trust according to standards that you set.

Assets within the credit shelter trust may grow, but are not a part of the surviving spouse's taxable estate.

When the second spouse dies, the assets in the credit shelter trust are distributed to the named beneficiaries according to the terms of the trust. The trust assets will not be included in the taxable estate of the second spouse. The surviving spouse still has his or her applicable credit available to offset estate taxes that may be due on his or her death. So, bottom line, a credit shelter trust lets a married couple transfer up to $10,900,000 to children or other beneficiaries with no estate tax liabilities.

Credit Shelter Trust

Portability

But what if a married couple does not have credit shelter trust planning in place?

If you leave all of your assets to a spouse, there is no estate tax because of the unlimited marital deduction. However, taxes may still apply at the second death.

Let's assume when the second spouse dies the total estate is then worth $10,900,000. The beneficiaries would ordinarily have to pay estate taxes on the portion of the estate that exceeds the second spouse's $5,450,000 applicable exclusion. If we apply only the second spouse's exclusion, the out-of-pocket estate taxes due would be $2,180,000.

The beneficiaries receive only $8,720,000 of the $10,900,000 estate because the first applicable exclusion was not utilized.

Without Credit Shelter Trust

But, with the passage of The 2012 Taxpayer Relief Act, the first deceased spouse's exclusion may not be lost.

The 2012 Taxpayer Relief Act allows the deceased spouse's executor to elect to transfer all (or part) of the deceased spouse's estate tax exclusion to the surviving spouse. This process is referred to as making a "portability" election. In effect, portability allows the deceased spouse's unused exclusion to be transferred to the surviving spouse. Note that the portability election is only available for married couples.

Let's take a look at an example of how portability could work in an estate plan (see graphic below).

Let's assume we have a married couple with a $10,900,000 estate who either did not have credit shelter trust planning in place or was unable to take full advantage of that planning opportunity.

The first spouse dies, leaving the entire $10,900,000 estate to the surviving spouse. The surviving spouse can elect to use the deceased spouse's unused exclusion amount. When the second spouse dies, both exclusions are available.

Portability of Estate Tax Exclusion

Portability is simple and allows for flexibility in maximizing the use of the estate tax exclusions, but portability has some risks and disadvantages as well.

First, it is only available if affirmatively elected. If the estate does not file the necessary return to make the election, the opportunity is lost.

Second, if you live in a state that imposes its own state-level estate tax, portability will not be effective to transfer any state exclusion.

Third, the transferred exclusion is fixed and does not grow. If the surviving spouse lives for a number of years and the inherited assets grow, any growth would not be protected from estate tax.

Fourth, the benefit of the portability election can be lost if the surviving spouse remarries and then survives the “new” spouse. Federal tax law specifies that you can use only the additional exclusion transferred by your most recently deceased spouse. So if you survive more than one spouse, the benefit of the transferred exclusion can be lost.

In contrast there are several reasons to discuss credit shelter trust planning with your estate planning attorney.

First, any appreciation in the assets that are funding the credit shelter trust is not subject to estate taxes upon the second death.

Second, the first deceased spouse controls who will benefit from the credit shelter trust. This may be important if the spouses' beneficiaries differ, as often occurs in a second or subsequent marriage.

Third, a credit shelter trust may provide some asset protection to the surviving spouse depending on state law.

And finally, this is an opportunity to shelter assets from the effects of any future tax law changes.

QTIP marital trust

If you or your spouse has children from previous marriages, you may intend to leave certain assets to those children. You may also want to ensure that your spouse has use of the assets during his or her lifetime. A qualified terminable interest in property trust, also known as a QTIP trust, is an irrevocable marital trust commonly used in these circumstances.

Let's see how a QTIP Trust works (see graphic below).

In this example, Martin and Michael each have been previously married.

Martin and Michael each want their own children from the previous marriage to benefit from their own assets. Martin also wants to help provide financial security to Michael, but wants to be sure that when Michael dies any remaining assets are distributed to his three children – not Michael's children.

To meet this objective as well as accomplish their other estate planning goals, they can include provisions for a QTIP trust in their wills or revocable living trusts. The QTIP trust is often used in conjunction with a credit shelter trust.

Let’s say Martin is the first spouse to die. At that time, his assets in excess of the amount transferred to a credit shelter trust are used to fund the QTIP trust and are not subject to estate taxes because of the unlimited marital deduction. Instead, the potential estate tax liability is deferred until Michael’s death, when the assets are included as part of his estate to calculate the estate tax.

When Michael dies, his assets are distributed to his designated beneficiaries, and the assets from Martin’s QTIP trust and Martin’s credit shelter trust are distributed to Martin’s designated beneficiaries. Michael’s assets and the QTIP trust assets may be subject to estate taxes when Michael dies. If the amount of assets in Michael’s estate plus Martin’s QTIP trust exceeds the applicable exclusion amount ($5,450,000 per individual in 2016), the beneficiaries will have to pay estate taxes.

Qualified Terminable Interest Property Trust

Keep in mind the examples used in this section are focused on federal estate tax law. Several states have their own estate taxes that may impact your estate plan. This can get complicated, so be sure to address state-specific issues with your tax and legal advisors to determine if additional planning is needed in your situation.

Let’s also take a minute to consider nontax reasons why some individuals choose to leave assets in trust for a spouse, partner, or child instead of making an outright transfer.

If your partner or spouse is a physician, attorney, CPA, entrepreneur, or might be subject to liability for any other reason, a trust might provide the surviving spouse or partner with some additional asset protection benefits.

A trust could also be considered if you want to help provide for the financial security of a spouse or partner, but still would like to retain control over how assets are distributed after the surviving spouse or partner dies.

Or in some cases, you might want to appoint a trustee who can manage trust property and investments, if your spouse or partner is inexperienced in financial matters, not inclined to be involved in management, or simply a busy professional who would benefit from having financial matters delegated to someone else.

Every situation is different, so what is "best" depends on your specific situation. Your attorney can help educate you about the advantages and disadvantages of using trusts.