Legislation passed at the end of 2010 raised the amount an individual can exempt from federal estate tax to $5 million, but there's also another provision in the law that helps married couples. Referred to as estate tax portability, the new law means that widows and widowers can now add the deceased spouse's exemption to their own -- giving the surviving spouse an exemption of up to $10 million.
Married couples have always been able to transfer assets tax-free during life, and at death through the unlimited marital deduction. But upon the death of the second spouse, the unused exemption of the first to die would usually be lost unless the couple set up a special trust, called variously a bypass, credit shelter or family trust. A fund equal to the exemption amount of the first spouse to die would be placed in the trust, which would distribute income and principal to the family while the surviving spouse was still alive. Once the second spouse died, the remainder would pass to the family, free of federal estate tax.
Although couples can still set up a bypass trust, with the new law they don't need to do it for the sole reason of avoiding federal estate tax. But the catch is, the law is only in effect through 2012 at this point.
"The portability for the estate tax exemption is great news if you know you are going to die in the next two years and you have under $10 million in wealth! But for those of us who don’t know when we are going to die, it is a bit trickier. There is no set answer as to what the amount of the estate tax exemption will be, or if portability will exist in 2013 and on," according to Leslie Corcoran, Certified Financial Planner and owner of Family First Financial Planning in Stuart, Fla.
So what should wealthy couples do? Corcoran advises them to review current documents and reconsider answers to these questions before deciding on the best plan of action:
1. Do my current documents still make sense with regard to distribution choices? By solely using the exemption portability, the estate could be subject to creditors, and appreciation of the estate is not protected, as it would be in a trust.
2. Are my current documents flexible to account for ever-changing estate tax rules? Attorneys can draft documents to account for the exemption in place at the time of death, rather than on a set amount of money.
3. Can I make current gifts now to reduce my overall estate later? Many clients prefer to see the beneficial effects of their financial gifts while they are alive, and gifts given during life are tax-exclusive (other assets used to pay gift tax are not part of the taxing equation), where at death they are tax-inclusive.
Finally, it's important to note that portability is not automatic; it has to be selected on the estate tax return.
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