Many people avoid the estate planning discussion for a variety of reasons—no one wants to think about dying, many are reluctant to analyze personal financials and assets, and with so many changes scheduled to occur in early 2013, why not just wait? The excuses are never-ending. The bottom line is that at some point we will pass away, and at that time, what will happen to your estate? What are the estate-tax consequences of passing your assets to your loved ones?
Today’s post highlights a way that couples can maximize federal estate-tax savings without costly predeath estate planning. The IRS issued guidance in June for an estate-tax law that Congress passed in late 2010.
Currently, an individual’s estate is exempt from federal estate-tax liability up to $5.12 million, or roughly $10 million per couple. The IRS guidance seeks to address the long-standing estate-tax issue for married couples. Beginning in 1981, each spouse has been allowed to leave property tax-free to their surviving spouse. The problem is that when a partner left all assets to the other, then this tax-free transfer in effect cost the couple one of their two estate-tax exemptions. When the surviving spouse passes away, they are only allowed one exemption for the entire estate.
One Solution: Trusts
To combat the problem, many planners began devising trusts to further shelter the assets from estate-taxes. However, these trusts are often costly to create and an administrative burden to maintain. This solution also forced couples to plan ahead, which many fail to do for the reasons I highlighted in the first paragraph of this post.
The New Rules
Under the new rules, when the first spouse dies the executor files an estate-tax return, which preserves the value of that spouse’s $5 million exemption. Then, at the time the surviving spouse dies, both $5 million exemptions can be utilized to maximize the couple’s estate-tax savings.
For example, let’s say a couple has collective assets worth $8 million—$6.5 million owned by the husband and $1.5 million owned by the wife. If he passes away then his estate will pass to the wife tax-free. When the wife later passes away, leaving the entire $8 million estate to her heirs, only $5 million is exempt from federal estate-taxes. However, under the new rules, if the executor files an estate-tax return when the husband passed away, then his $5 million exemption is essentially passed to the wife, giving her the ability to pass the entire $8 million to her heirs tax-free.
What if you have assets far below the $5 million exemption?
Most estate planning advisers still advocate filing the estate-tax return to preserve the dead spouse’s exemption. The idea is that it’s better safe than sorry, e.g. the surviving spouse receives some sort of windfall and his or her estate balloons in value.
Many experts believe that these new portability rules will be incorporated into the new estate-tax regime (coming January 1, 2013), regardless whether the exemption drops to $1 million—which it is scheduled to do—or not.
If you’re interested in learning more about estate planning strategies for you and your spouse or you’d like to learn more about the new portability rules, please feel free to contact us for your free consultation today.