Avoiding Costly Estate Tax for a Simultaneous Death

I ran into this estate tax question a few days ago that I found interesting. But not interesting so dramatically or spectacular to warrant a long law review article or other long-winded commentary. Nonetheless, many readers might find this brief summary useful.

This question centers on maximizing estate tax savings. Specifically, dealing with portability of the estate tax exemption for a married couple, and how the unlikely event of both spouses’ simultaneous deaths can adversely affect portability.

As a backdrop, a fundamental checklist item for any married-couple estate planning is purposely to preserve the use of each spouse’s full estate exemption. As I illustrate by example below, lack of planning for a simultaneous death can cause a loss of portability and a surprise increase in estate tax.

Point One. All married couples’ Wills need to include an express provision governing how the spouses’ estates operate in the (unlikely) event of a simultaneous death. For example, both spouses die in a plane crash. This express provision must be included in simple and complex Wills. In all Wills, in my opinion.

Point Two. If the Will does not include a simultaneous death provision, then state law generally by default applies. For example, Georgia law (like many states) provides that a simultaneous death is treated as though each person survived one another. Georgia’s default statutory law is the “Uniform Simultaneous Death Act in Georgia”, at O.C.G.A. § 53-10-1 et seq.

This “survived one another” is a brain-twister and might provide some level of novel, mental gymnastics over drinks. But, its operative essence – for example with a married couple – is that neither spouse is treated as receiving any of the estate from the other spouse. Their Wills are then applied to the next level of beneficiaries. Their children in many cases.

Point Three. You can google and find various tax commentators who make the point that the federal portability tax regulations do not address simultaneous death. This is correct. And another reason a Will must include its own simultaneous death provision, so as to trump the above state law “survived one another” result and insulate against the absence of clarity under the portability tax regulations.

Also, simply put, a state law “survived one another” result will cause a married couple to lose the benefit of portability. You can play around with the math and this concept, etc. And, below is an example:

Assume a married couple H and W die in a common disaster. W has $7.1 million of assets. H has $1.8 million. Combined total $8.9 million. H and W are both under the combined $10.98 million estate exemption amount. Ideally no estate tax.

But, in this example H and W have no provision in their Wills otherwise spelling-out that one spouse is deemed to have predeceased the other spouse in the event of a simultaneous death. Absent this Will provision, state law applies to H and W in this example so that H and W by default are treated as each surviving one another.

H and W in this example have disastrous estate tax planning. They will pay $644,000 estate tax in W’s estate even though their estate values are below their combined $10.98 million estate exemption amount. [I do not compute any potential state death tax in this example.]

This estate tax exposure is because W’s $7.1 million estate value exceeds her $5.49 million exemption. Triggering W’s estate tax of $644,000 [40% of $7.1 million less W’s $5.49 million exemption = $644,000 tax].

Why this costly result?

H and W lose portability in this example. Under default state law they are treated as each surviving one another. No property from one spouse passes to the other spouse. Also, in this example H’s unused estate exemption does not pass to W. Here there is a complete loss of H’s portability for his unused exemption. [H has a $1.8 million estate less than his available $5.49 million exemption.]

Point Four. Each Will for a married couple must include a presumption of death provision in the unlikely event of a simultaneous death. In some cases, practitioners opt for designating the spouse with the greater estate value as being the spouse presumed to die first.

But, as to the specifics of this simultaneous-death provision, I frankly see no need in every case for portability purposes to worry which spouse has (or might have) the greater assets.  Rather, just make sure – likely in most all cases – you designate one of the spouses (whether H or W) as being the spouse expressly deemed to predecease the other spouse in the event of a simultaneous death.

Rethinking the 30-Year Old Pecuniary Marital / By-Pass Trust Formula

For the past 30 years the majority of married couple Wills (or revocable trusts) have included a marital / by-pass trust with a built-in mathematical formula. The formula determines what portion of the first-to-die spouse’s estate ends up in the marital trust versus what portion in the by-pass trust.

The by-pass trust under this longstanding formula ends up typically with the first-to-die spouse’s full available estate exemption amount plus the appreciation of the first spouses’ estate assets during the estate administration (prior to funding the trusts). The martial trust ends up with the balance.

The above 30-year approach is outdated in my opinion. Why?

It will produce in many cases unnecessarily increased income tax exposure from the compressed top marginal income tax rates applicable to trusts. It also will result in loss of a second stepped-up basis for the by-pass trust assets at the surviving spouse’s death.

Below is a more modern planning option:

This newer approach uses a pecuniary formula that gives the QTIPable marital trust an amount equal to the full value of the first spouse’s estate (not including qualified retirement accounts).   Essentially under this approach this QTIPable marital trust gets the entire first-to-die spouse’s estate based on the date of death value of the assets. By contrast, the QTIPable by-pass trust gets all the appreciation of the assets during the estate administration.

Why this newer approach?

One. This is an excellent design regardless of whether a married couple ends up over or under the inflation-adjusted $10 million combined estate exemption.

Two. This modern approach gives the surviving spouse the ability to choose full estate exemption portability of the first spouse’s estate, if desired. Portability can put into place a second stepped-up basis for the first-to-die spouse’s assets, again if desired. In addition, a full or partial QTIP election is available for either or both the marital trust and by-pass trust.

Three. This QTIPable trust design for both the marital trust and by-pass trust can include certain other bells and whistles so as to make either or both QTIP trusts defective for income tax purposes as to the surviving spouse. This helps reduce or eliminate the marginal income tax rate exposure.

Bottom line:

The above modern design provides optimal future flexibility that enables the surviving spouse to choose the best course of action for both estate and income tax savings, based on a response to the tax laws and circumstances at the first spouse’s death.

By contrast, the 30-year old marital / by-pass plan locks both spouses into inflexible options prior to the death of the first spouse. I general don’t like getting boxed in in this manner. Far too restrictive.