By Darlynn Morgan, California Estate Tax Attorney
On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Tax Act”). In a nutshell, it did five things: extended current unemployment benefits to 99 weeks, extended current income tax rates (the Bush tax cuts) for all taxpayers for two more years, made significant changes to the estate tax applicable to those dying in 2010, 2011, or 2012, modified the gift tax for 2011 and 2012, and modified the Generation Skipping Transfer Tax for 2010, 2011, and 2012.
This is Part 2 of a 3 part series in which we will look at how these temporary changes can affect your estate planning. Click ahead at any time to read part one or part three.
Portability of Estate Tax Exemptions between Spouses
The estate tax law provides an unlimited deduction for assets left to a surviving U.S. citizen spouse. Therefore, the first spouse who dies can leave everything to the surviving U.S. citizen spouse and no estate taxes will be due upon the first death. Most married couples like this arrangement because it’s easy to administer and all of the assets are available to the surviving spouse. For those who died before January 1, 2011, and for those whose surviving spouses live beyond December 31, 2012, however, a big problem can occur because the estate tax exemption that could have been used at the first death is not available to shield assets in the surviving spouse’s estate.
For those couples in which both spouses die between January 1, 2011, and December 31, 2012, the Congress tried to fix this problem with something called “portability.” Under the 2010 Tax Act, if one spouse dies in 2011 or 2012, the Executor of the deceased spouse’s estate may transfer any unused federal estate tax exemption to the surviving spouse by so electing on a timely filed estate tax return. But, the transferred exemption must be used before December 31, 2012, or it is lost. Also, only the most recent deceased spouse’s unused exemption may be used by the surviving spouse, which could impact the surviving spouse’s decision to remarry.
For example, let’s say that after Jack dies, Jill marries Bill. If Bill dies before Jill does, Jack’s unused exemption would no longer be available to Jill. And Bill may have little or no unused exemption to transfer to Jill.
Even with temporary portability, relying on the unlimited marital deduction can cause other problems. For example, by leaving everything to Jill, Jack has no control over how his share of their estate is managed or distributed. Jill can do whatever she wants with the assets, including disinheriting any children Jack may have from a previous marriage. Also, any growth on the assets will be included in Jill’s estate when she dies and will be taxed at the rate in effect at that time. (Remember, the estate tax exemption will be just $1 million with a 55% maximum tax rate in 2013 unless the Congress acts.)
If Jack and Jill plan ahead, they can make sure they use both of their exemptions. Their wills or living trusts could include a provision that splits their $10 million estate into two trusts of $5 million each. When Jack dies, his trust uses his $5 million exemption and when Jill dies, her trust uses her $5 million exemption. This reduces their taxable estate to $0, letting them leave the full amount to their beneficiaries. (This tax-planning provision is often called an A-B trust or credit shelter trust.)
There are other benefits to this planning. For example, Jack can keep control over how his share of their estate is managed. He can choose his own beneficiaries, which may or may not be the same as Jill’s. The assets in his trust are valued and taxed only when he dies, so any growth on these assets will not be included in Jill’s estate when she dies. And even though the assets remain in Jack’s trust, they still can be available to provide for anything Jill needs.
Planning Tip: The portability provision may work fine for some couples. But you may still prefer the benefits of the A-B (credit shelter) trust, especially if you have a “blended” family. Also, if you use a living trust and properly fund it (transfer your assets to it), you will avoid probate which, depending on where you live, could save your family thousands more.
Gifting in 2011 and 2012
For 2011 and 2012, the gift tax exemption is $5 million per person ($10 million for a married couple), with the tax rate above the exemption at 35%. This exemption is unified with the estate tax exemption, so any unused amount can be transferred to the surviving spouse under the portability provision.
You can still make annual tax-free gifts of $13,000 ($26,000 if married) to as many individuals as you wish each year. (This amount is tied to inflation and is adjusted from time to time.) If you give more than this, the excess is considered a taxable gift and goes against your lifetime gift/estate tax exemption. ($5 million through 2012, $1 million thereafter.)
Part 2- Conclusion
Now is the perfect time to move forward with your estate, retirement and disability planning.
The 2010 Tax Act provides tremendous planning opportunities to transfer vast amounts of wealth for families with estates of all sizes, but it is a limited time opportunity that expires on December 31, 2012. At the same time, individuals with estates of less than $5 million and married couples with estates of less than $10 million can focus on planning that concentrates on family goals and objectives without, at least for the next two years, having to jump through hoops to avoid federal estate taxes. Of course, state death taxes and income taxes must still be considered.
We are ready to help you define your personal and financial goals and desires, and take advantage of these unique planning opportunities. Contact me, your California Estate Tax Attorney at (949) 260-1400 for a consultation.