Q: I understand that there has been a recent change in how the estate tax exclusion works for married couples. Can you explain that change and how it affects estate planning?
A: Effective for estates of those dying after 2010 and before 2013, the recently passed Tax Relief Act allows a deceased spouse's unused exemption to be shifted for use by the surviving spouse, with the executor making the irrevocable election on a timely filed estate tax return.
Estate Tax Exclusion
For estates of individuals dying in 2009, the top estate tax rate was 45% and there was a $3.5 million applicable exclusion amount. There was no estate tax for 2010.
The decedent’s estate can pass free of tax to the decedent’s spouse. This is known as the “marital deduction”.
Before the enactment of the 2010 Tax Relief Act, tax law did not allow for any unused portion of a decedent's applicable exclusion amount to be used by the estate of the decedent's surviving spouse. Without estate planning, this valuable left-over exclusion amount was forever lost.
Traditional Two-Trust Estate Plan
To take advantage of each spouse’s exclusion amount, married couples typically implemented a two-trust estate plan:
(1) a “credit-shelter trust” would make use of the deceased spouses applicable exclusion amount, and
(2) a “marital trust” qualifying for the marital deduction.
New Portability Feature
Under the 2010 Tax Relief Act, for estates of those dying after 2010 and before 2013, the applicable exclusion amount is the sum of (1) the “basic exclusion amount” and (2) in the case of a surviving spouse, the “deceased spousal unused exclusion amount.”
The basic exclusion amount is $5 million with an adjustment for inflation after 2011.
Effect on Estate Planning
In theory, the portability provision should negate the need for what is often complex estate planning to make it possible for each spouse to use the amount of the applicable exclusion needed to minimize estate taxes as much as possible.
However, because the provision sunsets after 2012 (unless further extended by Congress), married couples may still want to try to maximize the amount of the exclusion used in the estate of the first to die and provide an exclusion in the estate of the second to die.
Even if the portability provision does not sunset after 2012, there are still other reasons to employ the traditional two-trust estate plan to save taxes and protect assets of the estate. A credit-shelter trust may protect appreciation occurring between the death of the first spouse and the death of the second spouse from being subject to estate tax. Such a trust also can protect against creditors. Plus, the transferred exemption may be lost if the surviving spouse remarries and is again widowed.
Count on Your CPA
As you start your adult financial life, it’s a good idea to get to know your local CPA. He or she can help you understand your choices and make the best decisions for your financial future. You may contact me at (409) 892-0233 or (409) 883-5306. My email address is brad@ekc-cpa.com.
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- Estate Tax Exclusion
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- Effect on Estate Planning
- Count on Your CPA
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