The Fiscal Cliff and the Estate Tax

Christopher L Cauble

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Estate Planning Attorney

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The “Fiscal Cliff" negotiations are done and the law has been signed. Many people know about the affects of the income tax on the wealthy and the expiration of the payroll tax on Americans. However, what happened to the Estate Tax? Also, what should people do to plan if they may be affected by the estate tax? Bottom line - the estate tax exemption, lifetime gift tax exemption and generation skipping transfer tax exemption will each be $5.25 million for 2013 and indexed for inflation in later years, and the tax rate will be 40%. “Portability" of the of the estate tax on married couples was made permanent.

What does “portability" mean?

Portability of the federal estate tax exemption between married couples means that if the first spouse dies and the value of his or her estate does not require the use all of his or her federal exemption from estate taxes, then the amount of the exemption that was not used for the deceased spouse's estate may be transferred to the surviving spouse's exemption so that he or she can use the deceased spouse's unused exemption plus his or her own exemption when the surviving spouse later dies.

Some examples using numbers should help to illustrate the concept of portability of the federal estate tax exemption between spouses:

Result Without Portability

Assume Sam and Jane are married and have all of their property and assets are jointly held and their net worth is $8,000,000, Sam dies first and the federal estate tax exemption is $5,250,000 on the date of his death, and portability of the estate tax exemption between spouses is not in effect:

Under these facts, when Sam dies his estate will not need to use any of his $5,250,000 estate tax exemption since all of the assets are jointly titled and the unlimited marital deduction will allow

Bob's share of the joint property to be automatically transferred to Jane by right of survivorship without incurring any federal estate taxes.

Assume that at the time of Sue's later death the federal estate tax exemption is still $5,250,000, the estate tax rate is 40%, and Sue's estate is still worth $8,000,000.

With Sam's $5,250,000 estate tax exemption completely wasted, when Sue later dies she can only pass on $5,250,000 free from federal estate taxes. Thus, Sue's estate will owe about $1,100,000 in estate taxes after her death:

$8,000,000 estate - $5,250,000 exemption = $2,750,000 taxable estate

$2,750,000 taxable estate x 40% estate tax rate = $1,100,000

Result With Portability

Assume Sam and Jane are married and have all of their assets jointly titled and their net worth is $8,000,000, Sam dies first and the federal estate tax exemption is $5,250,000 on the date of Sam's death, and portability of the estate tax exemption between spouses is in effect:

As above, when Bob dies his estate will not need to use any of his $5,250,000 estate tax exemption since all of the assets are jointly titled and the unlimited marital deduction allows for the automatic transfer of Bob's share of the joint assets to Sue by right of survivorship and without incurring any federal estate taxes.

Assume that at the time of Sue's later death the federal estate tax exemption is still $5,250,000, the estate tax rate is 40%, and Sue's estate is still worth $8,000,000.

Enter portability of the estate tax exemption - Using the concept of portability of the estate tax exemption between spouses, under these facts Sam's unused $5,250,000 estate tax exemption will be added to Sam's $5,250,000 exemption, in turn giving Sam a $10,500,000 exemption.

Since jane has "inherited" Bob's unused estate tax exemption and she can pass on $10,500,000 free from federal estate taxes at the time of her death, Jane's $8,000,000 estate will not owe any federal estate taxes at all:

$8,000,000 estate - $10,500,000 exemption = $0 taxable estate

Thus, portability of the estate tax exemption will save the heirs of Sam and Jane about $1,100,000 in estate taxes.

Please note that Jane will not automatically "inherit" Sam's unused exemption; instead, she must timely file IRS Form 706, United States Estate and Generation Skipping Transfer) Tax Return, in order to make an affirmative election to add Sam's unused exemption to her exemption.

Of course, these examples illustrate how portability of the estate tax exemption between spouses really works in the same way that the AB Trust system works but without the need for setting up AB Trusts.

(Illustrations/examples borrowed from What is the Portability of the Estate Tax Exemption? Julie Garber)

What Planning should you do?

If you have significant assets that subject you estate tax exposure, you should talk to an attorney or accountant about planning. The actions of Congress did protect many Americans from potential exposure. However, Many Americans are still potentially impacted by Federal estate taxes. Additionally, many states have estate taxes. For instance, Oregon estates have a threshold of 1 million dollars with NO portability. Congress also eliminated the revenue sharing aspect of the estate tax. This may cause other states, like California, to pass their own estate tax legislation in order to replace their lost revenue. Based on this, smaller estates may be subject to estate taxes again.

Additional Resources

http://www.forbes.com/sites/deborahljacobs/2013/01/02/after-the-fiscal-cliff-deal-estate-and-gift-tax-explained/

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