Though it’s still true that you can’t take it with you, a recent tax law change makes it easier to reduce or eliminate estate tax liability for your heirs. Thanks to a “portability” provision that’s now part of the law, any unused portion of the individual exemption from federal estate tax that isn’t used by the estate of the first spouse to die may be claimed by the surviving spouse’s estate.
This special estate tax break, first enacted in 2010, was set to expire after 2012. However, the American Taxpayer Relief Act (ATRA) extended it for 2013 and thereafter. Barring drastic change, you can count on portability for the foreseeable future.
Under ATRA, the federal estate tax exemption is locked in at a generous $5 million that is increased annually to account for inflation. (The exemption for 2015 is $5.43 million.) As a result, a couple in 2015 can transfer up to $10.86 million without incurring a dime of federal estate tax.
Suppose a husband owns $4 million on his own, his wife has $3.5 million, and they hold $2.5 million in both their names—jointly with rights of survivorship, in legal jargon. Each spouse’s will leaves his or her entire estate to the other spouse and, upon the death of that spouse, to the couple’s children.
Now suppose that the husband dies first in 2015. Because all of his individually owned assets pass to his wife, his estate needn’t use any part of his federal estate tax exemption. (Spouses normally can inherit an unlimited amount from each other without estate taxes.) So the wife now owns all of the couple’s assets, worth a total of $10 million. When she dies, that $10 million in assets goes to the couple’s children. Without portability, the wife would have only her own exemption, and that would leave her estate responsible for estate taxes on $4.57 million (the $10 million in assets minus her $5.43 million exemption). At the current 40% estate tax rate, the estate would owe more than $1.8 million—money that wouldn’t go to the children. With portability, however, the combined exemption of $10.86 million more than covers the $10 million in the estate, and the heirs pay no estate tax.
As beneficial as the portability provision can be, it won’t necessarily solve every potential estate-planning problem. For example, it still might be a good idea to establish a bypass trust, a tool that, before portability, could be used to maximize the estate tax exemptions of married couples. Although no longer needed for that purpose, a bypass trust still could be used to protect assets from creditors, guard against other tax consequences, such as the generation-skipping tax, and be especially helpful in allocating assets when one or more spouse has children from a previous marriage.
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