Thursday, March 12, 2015

Article Abstract – Preferred Interest Partnerships to Use DSUE Amounts Received by a Surviving Spouse

 

TITLE

Tasty Freeze: Preferred Partnership Tax-Saving Recipe

AUTHOR(S)

Michael N. Gooen and Tracy A. Snow

PUBLICATION

Estate Planning Journal - May 2015

PUBLISHER

WG&L

ABSTRACT (Key Points & Discussions)

    • Surviving spouse's can obtain the use of the unused unified credit amounts of their predeceased spouse (DSUE) if a portability election is made. However, if the surviving spouse remarries, and their new spouse dies before them, then the DSUE from the first spouse is lost and the DSUE, if any, from the latest spouse to die applies instead. If this new spouse has a smaller DSUE than the first spouse that died, the surviving spouse's estate ends up with a smaller available DSUE.
    • To avoid this, surviving spouse's will often want to make a gift to use up the DSUE of their first deceased spouse before they remarry. If the DSUE of that first deceased spouse is used by the surviving spouse during lifetime before the death of a new spouse, the surviving spouse does not lose the benefit of that first deceased spouse's DSUE amount.
    • However, often the surviving spouse is not comfortable gifting away significant assets for this purpose - he or she may need those assets for support or for a rainy day fund.
    • The authors suggest that the surviving spouse capitalize a partnership with preferred and common interests, and then gift away the common interests. It is intended that the surviving spouse INTENTIONALLY triggers Section 2701, which results in the surviving spouse making a taxable gift that includes both the value of the transferred common interest, AND the preferred interest retained by the surviving spouse (which preferred interest has the lion's share of the real value). The surviving spouse uses the DSUE amount to avoid gift tax on this transfer.
    • At the surviving spouse's later death, all growth in the partnership in excess of the preferred payments paid to the surviving spouse will have been transferred free of transfer tax to the gift recipients of the common share, based on the nature of the common interest and the frozen upside of the preferred interest. While the retained preferred interest of the surviving spouse will be subject to estate tax inclusion, there will be an offsetting reduction for the amount of that interest that was previously subject to gift tax under Section 2701, thus not creating any additional overall transfer taxes. The surviving spouse has thus (a) been able to use the DSUE to make a gift, even though still retaining cash flow from the gift via the retained preferred interest, and (b) shifted post-formation appreciation to the gift recipients free of transfer taxes. A step-up in basis for the spouse's retained interest may also apply, which can be applied within the partnership via a Section 754 election.
    • Other possible enhancements to this technique include making the transfer to a defective grantor trust (so that the surviving spouse has to pay the income taxes on the transferred interest and thus reduces the size of her estate without taxable gift), and making the preferred interest of the spouse noncumulative (so as to preserve flexibility to limit unnecessary growth in the spouse's estate).

RESEARCH TAGS

DSUE, Partnership Freeze

 

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