The Underfunded Credit Shelter and the Portability Decision
Ruth died in 2023 with a gross estate of $9,000,000 and a will containing a formula credit-shelter trust funded with the maximum amount that can pass free of federal estate tax, residue to her husband, Sam. The executor, Sam, is also the sole beneficiary of the residue. The estate's only deductions are $150,000 of administration expenses and $50,000 of debts. Ruth made no lifetime taxable gifts. Sam is 78, in declining health, and has an estate of his own valued at $4,000,000. The executor timely filed Form 706 but did not affirmatively elect portability, believing the formula trust captured everything available. The applicable exclusion amount for 2023 was $12,920,000.
1. Compute the credit-shelter funding amount and the residuary passing to Sam, and explain the effect of the formula.
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Adjusted gross estate = $9,000,000 − $150,000 − $50,000 = $8,800,000. Because the entire estate is below the $12,920,000 exclusion, the formula clause-funding the trust with the maximum that passes free of tax-funds the trust with the entire $8,800,000. The residue to Sam is $0. The formula therefore leaves Sam with nothing outright and leaves the estate with no unused exclusion to port, because the credit shelter absorbed all available exclusion (or, depending on drafting, the trust is funded at the full exclusion amount and the residue is zero). Either way, portability is moot: there is no DSUE to elect.
2. Sam asks whether failing to elect portability harmed him. Analyze the consequences given his own $4,000,000 estate and declining health.
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No harm in dollar terms, but for a subtle reason. The formula trust was funded with the full $8,800,000, consuming Ruth's exclusion; there is no DSUE to port. Sam's own $4,000,000 estate is below his own exclusion ($12,920,000 in 2023, subject to scheduled sunset), so he owes no estate tax on his death regardless. The real problem is loss of basis step-up and flexibility: assets in the credit-shelter trust will not get a second step-up at Sam's death, whereas assets in Sam's estate would. Because Sam is the trust beneficiary, counsel should consider whether the trust permits distributions or a limited power of appointment to shift assets back into Sam's estate for basis purposes-subject to the trust terms and any anti-abuse concerns.
3. If the executor now realizes the formula was drafted to fund the trust with the *exclusion amount* rather than the maximum tax-free amount, how would the numbers and the portability analysis change?
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If the trust is funded with the exclusion amount ($12,920,000), the trust cannot be fully funded from an $8,800,000 estate; it would absorb the entire $8,800,000 and the residue is still $0. A formula tied to the exclusion amount only produces a residue when the estate exceeds the exclusion. Since $8,800,000 < $12,920,000, the result is the same: trust funded with everything, no residue, no DSUE. The lesson is that formula clauses must be drafted to preserve portability (e.g., funding the trust with the exclusion amount only if the estate exceeds it, otherwise funding with a nominal amount and leaving the rest to the spouse), and executors must affirmatively elect portability on a timely Form 706 even when they think it is unnecessary.