What The New Tax Laws Mean For The Estate Tax Exemption Portability

Back in 1997, the lifetime estate tax exemption was $600,000 and the top estate tax rate was 55%.  The exemption increased through 2009 to $3,500,000 while the top tax rate declined to 45%.  For tax years 2011-2012 the exemption amount is $5,000,000 with a top tax rate of 35%.   However, in those prior years if the first spouse to die could not fully utilize the exemption amount because the value of the estate was below the exemption amount, the excess was lost forever.  For tax years 2011 and 2012, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 allows for the surviving spouse to add the deceased spouse’s unused exemption amount and add it to their $5,000,000 exemption.  The Joint Committee on Taxation Report provides a couple of examples:

Example 1.-Assume that Husband 1 dies in 2011, having made taxable transfers of $3 million and having no taxable estate. An election must be made on Husband 1’s Estate Tax Return to permit Wife to use Husband 1’s deceased spousal unused exclusion amount. As of Husband 1’s death, Wife has made no taxable gifts. Thereafter, Wife’s applicable exclusion amount is $7 million (her $5 million basic exclusion amount plus $2 million deceased spousal unused exclusion amount from Husband 1), which she may use for lifetime gifts or for transfers at death.

Example 2.-Assume the same facts as in Example 1, except that Wife subsequently marries Husband 2. Husband 2 also predeceases Wife, having made $4 million in taxable transfers and having no taxable estate. An election must be made on Husband 2’s Estate Tax Return to permit Wife to use Husband 2’s deceased spousal unused exclusion amount. Although the combined amount of unused exclusion of Husband 1 and Husband 2 is $3 million ($2 million for Husband 1 and $1 million for Husband 2), only Husband 2’s $1 million unused exclusion is available for use by Wife, because the deceased spousal unused exclusion amount is limited to the lesser of the basic exclusion amount ($5 million) or the unused exclusion of the last deceased spouse of the surviving spouse (here, Husband 2’s $1 million unused exclusion). Thereafter, Wife’s applicable exclusion amount is $6 million (her $5 million basic exclusion amount plus $1 million deceased spousal unused exclusion amount from Husband 2), which she may use for lifetime gifts or for transfers at death.

Example 3.-Assume the same facts as in Examples 1 and 2, except that Wife predeceases Husband 2. Following Husband 1’s death, Wife’s applicable exclusion amount is $7 million (her $5 million basic exclusion amount plus $2 million deceased spousal unused exclusion amount from Husband 1). Wife made no taxable transfers and has a taxable estate of $3 million. An election must be made on Wife’s Estate Tax Return to permit Husband 2 to use Wife’s deceased spousal unused exclusion amount, which is $4 million (Wife’s $7 million applicable exclusion amount less her $3 million taxable estate). Under the provision, Husband 2’s applicable exclusion amount is increased by $4 million – the amount of deceased spousal unused exclusion amount of Wife.

In order for the Executor of an estate to avail himself of this provision, he will have to file an Estate Tax Return, Form 706, compute the unused exemption amount, and make an election to provide the excess to the surviving spouse.  The election is irrevocable and must be made with the Estate Tax Return, filed on a timely basis, including extensions.

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Gabriel J. Markiz, CPA/PFS, CFP®

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