Estate PlanningEstate Tax

The Caveats of Estate Tax Exemption Portability

Thanks to the Taxpayer Relief Act of 2010, the estate tax exemption has been raised to a lofty $5.43 million for 2015, an amount that means that most clients won’t have to worry about the federal estate tax (unless they have a wealthy mindset!) It also fixes a part of the law that previously caused many headaches and spurred the creative estate planning industry: estate tax exemption portability.

Here’s how it works. Assume a husband (“H”) and wife (“W”) own $10 million in assets in their individual names. H dies in 2015, and leaves all of his assets to W, using the unlimited marital estate tax deduction. He used none of his $5.43 million exemption, so it is carried forward as a Deceased Spousal Unused Exemption Amount (“DSUE”), after his executor timely makes an election on his estate tax return. When W dies, she may take both her own exemption and H’s DSUE, totaling $10.86 million, and paying no estate taxes.

There are some matters that cloud the simplicity of this concept, however. We’ll discuss them briefly below.

  1. An estate tax return will be needed even though no tax is owed. The IRS requires an executor of a first-to-die spouse’s estate to file an estate tax return timely with an election to carry forward the DSUE. The statute of limitations on filing an estate tax return is typically three years, so if it becomes apparent after the first spouse’s death that the surviving spouse will need to use the DSUE, the return can be filed to save it.
  2. When a surviving spouse remarries after the death of the first spouse, the first deceased spouse’s DSUE is lost as soon as the second spouse dies. Only the DSUE of the last deceased spouse may be used, and any DSUE from a prior spouse’s death cannot be carried forward. The surviving spouse can circumvent this rule by making a gift before the second spouse’s death. For example: H1 dies leaving everything to W, thus creating a DSUE of $5.43 million for W. W remarries to H2, then gifts $5.43 million to an irrevocable “family” trust prior to H2’s death. The DSUE will be used on the lifetime gift.
  3. Portability does not apply to the Generation-Skipping Tax, which is also $5.43 million. If a spouse wishes to provide for his or her grandchildren, it is important to make this a consideration of the estate plan.
  4. Gifts that are made sooner rather than later are always advantageous, because the income and appreciation of those assets will also be shielded from the estate plan. Assume H dies leaving $5.43 million to an irrevocable “Family Trust” as used in traditional estate planning. Those assets will grow in the trust, and the accumulated income on those assets won’t count against W’s estate tax exemption. This is especially important in the case of assets that produce a lot of income, such as rental properties and closely-held income.
  5. In states with an estate tax, the portability rules do not apply. If you die in a state with an estate tax, it is still important to avoid it as the federal rules won’t save you from the state’s tax man.

As always, an estate plan should be individually tailored to each client. Carson Law Firm takes a holistic approach — we get to know our clients and make a strong effort to understand our clients’ needs. Every estate plan we recommend is custom-designed to fit the facts. Call today for a consultation — 888-403-1259.