9121 / What issues need to be weighed when a blended family is choosing whether to rely upon portability or trust options to ensure that both spouses’ estate tax exemptions are fully used?

However, if an individual does not wish to leave the bulk of his or her assets to the surviving spouse, a trust option can prove more effective for carrying out the individual’s wishes. Using trusts to provide for various family members’ inheritances can also help prevent family conflict after the first-to-die spouse’s death, as all heirs (including the surviving spouse, adult children and grandchildren) can be informed ahead of time to avoid unpleasant surprises that can lead to disagreement and even lawsuits.

Using a trust instead of portability can also create adverse tax consequences, however. As a general rule, the basis of property that has been acquired from a decedent is the fair market value of the property at the date of the decedent’s death (i.e., the basis is “stepped up” or “stepped down,” as the case may be, to the fair market value for estate tax valuation purposes). When portability is elected, the assets in the estate receive two basis adjustments—one after the death of the first-to-die spouse and one after the death of the surviving spouse, assuming the assets remain in the surviving spouse’s estate. When the same assets are held in a trust, the assets do not receive a step-up in basis at the death of the surviving spouse (assuming they are excluded from the surviving spouse’s estate, which is the goal of many trust options in blended family situations). If the assets appreciate substantially in value between the deaths of the two spouses, receiving a second step-up in basis can result in tax savings.²

Further, if the family resides in a state that imposes its own estate or inheritance tax, federal portability rules will not apply to those state-level taxes. The rates, exemption levels and how these taxes are imposed can vary significantly from state to state (i.e., the rate can vary based upon who inherits the property).