Portability Formulas in Estate Planning Documents, Part II: Post-Death Appreciation

A high-level view of some of the bounds to be considered

Table of Contents

1. Intro and Background

2. Rev. Proc. 64-19: Post-Death Appreciation and the Marital Deduction

3. Next Steps

Intro and Background

In the last article in this series, we discussed some of the nuances of modern tax funding formulas that are possible due to the portability election.  However, while these modern formulas make for a more flexible estate plan, they are not always easy to administer.  In fact, there are several issues relating to post-death income and appreciation in the value of assets that must be considered.  Over the next couple of articles, we will consider these issues in the context of using funding formulas. 

Why does this matter?  Well, as much as we like to think modern estate planning creates streamlined administration of estates and trusts, this is rarely the case.  It is common for some time to pass between the death of an individual, and the funding of bequests and devises in trust or otherwise.  In the meantime, we face the fact that asset values can fluctuate between date of death (or the alternate valuation date) and date of funding.  Further, assets can earn income during this time.  And, in a world where it is rare to pay estate tax, certain elections with respect to income tax must still be taken into account where a Form 706 is prepared (even if the 706 is not required, as may be the case for portability elections, QTIP elections, and/or final allocations of GST exemption. 

One of the biggest misconceptions in the administration world is that an executor, or trustee, has carte blanche to allocate assets between trusts or shares created under an estate or trust.  This is not the case where many funding formulas are involved.  In fact, the only “true” safe harbor we will see is the use of the fractional funding approach – which, for various reasons, is impractical for assets that are not conducive to fractional interests (especially real property and tangible personal property) or for which a valuation discount might hurt (if, for example, we are going for a basis step-up at second death).  If fractional funding is not used, post-death appreciation and income can affect the choice of assets used to fund trusts created under a formula. 

Traditionally, these issues came up where a traditional A/B funding formula was used.  A/B formulas usually choose one of two amounts to be expressed as a set pre-residuary dollar amount, also known as a “pecuniary” amount.  In other words, one of the two estate tax planning trusts we discussed – the marital trust, or the credit shelter trust, would be funded first based on a set dollar amount.  The residuary would then pass to the other trust.  For the credit shelter amount, if it was funded first, the funding limit would be based on the greatest amount (taking into account the applicable credit) that could pass to the trust without incurring any federal estate tax.  For the marital trust, it would be the smallest amount (taking into account the estate tax marital deduction) that could pass to the marital trust in order to generate zero federal estate tax. 

When the estate tax applicable exclusion was just 6 figures, it was common for the credit shelter amount to be expressed as the pecuniary, pre-residuary amount.  However, with the current high basic exclusion (projected at $13,999,000 in 2025), it is more frequently the case that the marital deduction amount gets expressed as the pecuniary, pre-residuary amount.  For reasons we will later discuss, the idea situation is that the smaller of the two amounts is the pecuniary amount. 

But, the guidance on this issue gets twisted when we encounter a plan using the portability-based elections discussed in the last article.  For example, if a surviving spouse disclaims to a credit shelter trust, should this same guidance be applied so that instead of disclaiming the remaining exclusion, instead the disclaimed amount is the lowest amount that can be disclaimed to create zero estate tax taking into account the marital deduction?  If we make a partial or Clayton QTIP election, do we have some leeway to determine this pecuniary amount as well?  It may be the case that a spouse, or executor or trustee, has more leeway to make these elections.  However, the manner of structuring the elections may matter more than we think when considering the “amount” with respect to which each election applies. 

So, how can we start coloring in the lines?  As our foundation, there are some rules relating to the marital deduction and funding formulas which are often outside of the scope of knowledge practitioners.  Knowing these baseline rules could avoid some headaches.

Rev. Proc. 64-19: Post-Death Appreciation and the Marital Deduction