The Federal Tax Relief Act that became law on December 17, 2010 contains a surprising
new provision that is designed to help married couples fully utilize both of their
lifetime exemptions from gift and estate taxes. An examination of the procedural
steps necessary to take advantage of the measure demonstrates that it is not foolproof
and should be thought of as a backstop rather than an exemption-saving panacea.
In 2011 and 2012, the lifetime exemption amount is $5 million. Certain types of
gifts are always exempt from the federal gift and estate taxes. The lifetime exemption
amount allows an individual to give, in addition to gifts that are always exempt,
$5 million in assets during life or at death without incurring any gift or estate
tax liability.
When a married person dies during 2011 or 2012, any portion of the spouse's $5 million
exemption that he or she did not use may be used by the surviving spouse’s estate
to reduce or eliminate the surviving spouse's estate tax liability. If the first
spouse to die uses none of his or her exemption, the entire $10 million may be used
by the surviving spouse. Note, however, that the executor of the first spouse to
die is not permitted to use any of the surviving spouse's exemption – the exemption
amount for the first spouse is set at $5 million.
To illustrate how this exemption transfer works, assume that the first spouse to
die, “A” passes away in 2011 or 2012 and that A made gifts worth $1 million during
life, thereby using $1 million of his $5 million exemption. He dies with an estate
of $2 million, and therefore uses $2 million more of his $5 million exemption to
transfer his entire estate free of estate tax. The part of the $5 million exemption
not used by A, $2 million, can be transferred by his or her executor to the surviving
spouse, “B.” When B dies, assets equal in value to the exemption amount available
to B under then-current law will pass to B’s heirs free of estate tax, and because
A’s unused exemption amount was transferred by A’s executor to B, up to $2 million
in additional assets will also pass to B’s heirs free of estate tax.
To take advantage of this exemption "portability," the executor for the estate of
the first spouse to die must make an election on an estate tax return to transfer
the decedent's unused exemption to the surviving spouse. The return must be filed
even if the filing of an estate tax return would otherwise not be required. If the
executor is not aware of the need to make the election, or if the executor misses
the IRS estate tax filing deadline and has not been granted an extension, the ability
to transfer the deceased spouse's unused exemption amount is lost. A failure by
the executor to make the election and to file it on time could mean a seven-figure
loss for the surviving spouse. For example, if the deceased spouse did not use $3
million of his $5 million exemption, a failure to transfer the $3 million remaining
exemption to the surviving spouse would result in estate tax liability of $1,050,000
for the surviving spouse's estate if the surviving spouse's assets exceeded the
value of her remaining exemption amount plus $3 million.
There are several reasons that an executor might fail or choose not to make the
election to transfer the deceased spouse’s remaining exemption, including indifference
toward the surviving spouse or even a desire to spite or “get even with” the surviving
spouse. This might occur, for example, if the executor is a child of a prior marriage
who feels that his or her parent was too generous with surviving spouse to the detriment
of the child.
Married couples who allow this potentially costly matter to ride on the reliability
and decision making of an executor are taking a serious and unnecessary risk. Credit
shelter trusts will continue to be an essential component of proper estate planning
for the well-to-do married couple.
