A Married Couple's Guide to Estate Planning

8/10/2019 A Married Couple's Guide to Estate Planning

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A MARRIEDCOUPLES GUIDE TO

ESTATE PLANING

DEBORAH L. JACOBS


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Fidelity Financial Co., LLCWhite Paper

Remember all that hand-The New Years Dayfiscal cliff bill, which ended an 11-year period ofuncertainty about estate tax exemptions and rates, alsomade permanent a wonderful break for widows and

widowers that was set to expire after a two-yearintroductory period. Starting for deaths in 2011, and nowgoing forward, widows and widowers can add anyunused exclusion of the spouse who died most recently totheir own $5.25 million tax-free amount. This enablesthem together to transfer up to $10.50 million tax-free. Italso eliminates the need in many cases for the tax-planning gyrations that lawyers routinely recommendedto preserve each spouses estate tax exemption amount.

Portability, as tax geeks call it (though that termdoes not actually appear in the American Taxpayer ReliefTax Act Of 2012 or ATRA), doesnt change the fact thatyou can give an unlimited amount to your spouse, duringlife or through your estate plan (provided she or he is aU.S. citizen) with no tax appliedthis is the unlimitedmarital deduction. But until portability became part ofthe law, without proper planning, when the secondspouse died anything above the exempt amount notgoing to charity would be taxed. In other words, the firstspouses exemption would be lost. Bypass trusts (alsocalled family trusts or credit-shelter trusts) addressed thatproblem.

Heres how these trusts work: When the firstspouse dies, the trust is funded with up to the tax-freeexemption amount. The trust distributes income andprincipal to the survivor or other family members

(usually the couples children) while the surviving spouseis alive, then passes on whatever is left to family. Funds inthe bypass trust are covered by the exemption amountand are not taxed when the first spouse dies. Nor are theyconsidered part of the survivors estate, so they are notsubject to tax when she dies.


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All this is still true, but portability makes itunnecessary for spouses to use bypass trusts solely topreserve the federal exemption amount. As with any newprocess there is a shakeout period, though. Here are

answers to some frequently asked questions:

Does this provision help me if my spouse died years

ago?

No. It applies only to deaths after Dec. 31, 2010.

Does portability apply to lifetime gifts as well as assets

that pass through an estate plan?

Yes. The lifetime gift tax exclusion and the estatetax exclusion are expressed as a total amount currently$5.25 million per person and it is possible to use thisexclusion (sometimes called the unified credit) totransfer assets at either stage or a combination of the two.If you exceed the limit, you (or your heirs) will owe tax ofup to 40%.

The IRS expects you to keep a running tally and

report these gifts so it will know how much has alreadybeen used up when you die. For example, if you haveused $1 million of the exclusion to make taxable lifetimegifts, the unused exclusion if you die in 2013 will be $4.25million, rather than $5.25 million.

Couples can share the basic exclusion during life(this process is called gift-splitting) and give more to thekids now, tax-free. But of course this also reduces howmuch of the tax-free amount will be available when theydie, either for their own use or to be carried over by thesurvivor.


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Does portability apply to same-sex married couples?

No, and theres no equivalent of the maritaldeduction for them either. Thats because the federal

Defense of Marriage Act of 1996 defines marriage as alegal union between one man and one woman, andspouse as a person of the opposite sex who is a husbandor a wife. (See my FORBES magazine article, Same-SexCouples Face A Raft Of Planning Issues, and WendyGoffes guest post, Will The Supreme Court LegalizeSame-Sex Marriage This Term?)

Does portability apply if the surviving spouse is not a

U.S. citizen?

No, and the marital deduction is much morelimited.

Is portability automatic?

No. The executor handling the estate of the spousewho died will need to transfer the unused exemption tothe survivor, who can then use it to make lifetime gifts or

pass assets through his or her estate.

The prerequisite is filing an estate tax return whenthe first spouse dies, even if no tax is due. This return isdue nine months after death with a six-month extensionallowed. (See my post, The Deadline Every MarriedPerson (And Financial Advisor) Needs To KnowAbout.) If the executor doesnt file the return or missesthe deadline, the spouse loses the right to portability.Spouses should file it even if theyre not wealthy today,because someday, who knows?

One would hope that the Internal Revenue Servicewill develop a short form for the purpose. Meanwhile, seemy post, How To Get The Latest Tax Break WithoutSpending A Bundle On Legal Fees.


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Is the amount thats portable adjusted for inflation?

No, but the surviving spouses own exemptionamount is. For 2013, it is $5.25 million. (The IRS

announcement of the 2013 inflation adjustmentdownloads here as a PDF.)

What happens if you remarry?That depends on whodies first you or your new spouse. For example, lets sayHarry had an unused exemption amount of $2 millionwhen he died in 2012 (say, because he left $3.12 millionto his children outright). His widow Sally has a $5.25million exemption amount of her own. As the executor ofHarrys estate, Sally files a return, transferring Harrys

unused exemption, so that she will then be able to pass$7.25 million tax-free (her own $5.25 million exemptionplus Harrys $2 million unused exemption). This year shemarries Joe.

If Joe dies before Sally, she can no longer useHarrys unused exemption amount only Joes. If Joesunused exemption is less than Harrys (or if he has nounused exemption at all), Sally is out of luck. On the

other hand, what if Sally dies first? She came into themarriage with a $7.25 million exemption amount,including the $2 million unused exemption from Harry.Assume she leaves $3 million to the children she andHarry had together. In that case, Joe can use theremaining $4.25 million exemption, along with his own.However, under the law the amount carried over cannever be more than $5.25 million.

Can I use my exclusion instead to provide forchildren from a previous marriage?Yes. You can dothis with just part of your exclusion amount or thewhole thing by leaving assets to them outright or in abypass trust.


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Does portability also apply to the exemption from

generation-skipping transfer tax?

No. This tax applies, on top of estate or gift tax, to

assets given to grandchildren (or to trusts for theirbenefit). Although there is no portability at death, fortransfers during life married couples can combine each oftheir exemptions to give away a total of $10.50 millionwithout incurring the tax.

Do I still need a bypass trust?

The trust has the advantage of shelteringappreciation and could also be helpful in situations where

you want to protect assets from creditors, use yourgeneration-skipping transfer tax exemption, or benefitchildren from a previous marriage.

If you live in a state that has an estate tax, factorthat into your analysis, too. Currently 22 states and theDistrict of Columbia have a separate estate tax, and nonehave portability provisions. By funding a bypass trust upto the state exemption amount ($1 million or less in most

states that have this tax), you shelter the first spousesexemption from state estate tax. See Ashlea Ebelingspost, Where Not To Die In 2012: A Guide To StateDeath Taxes.

Still, in many cases, where couples have combinedestates of $10.50 million or less, they might prefer toavoid the expense and inconvenience of a trust andsimply leave everything outright to each other in what is

called an I love you will.

When outright bequests to the surviving spousemake sense for estate tax reasons, there may also beincome tax benefits down the line. When the secondspouse dies, these assets, included in her estate, get anadjustment in basis to their date of death value, which


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minimizes the capital gains tax heirs must pay when theyare sold. In contrast, the basis on assets that went into thebypass trust when the first spouse died will not havechanged since then.

Is this a subject that should be covered in prenuptial

agreements?

Macabre as it may sound, inheritances often arethe subject of prenups, especially when there are childrenfrom a previous marriage. And wills often specify thefunds from which estate taxes should be paid (forinstance, its not tax efficient use retirement assets for thispurpose). So while this is certainly a new topic, if it

concerns you, its something you should address.


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Fidelity Financial Co., LLC

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StreetOmaha, NE 68114

Mark T. Houston

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A Married Couple's Guide to Estate Planning

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