Over the past fifteen years, the amount that could pass free of estate tax at death has ranged from $675,000 to an unlimited amount. Prior to 2010, if the first spouse to die did not utilize his or her estate tax exclusion amount, that amount would be lost forever. Special estate planning, usually in the form of an A/B or A/B/C Revocable Trust was needed in order to utilize the exemption amount of the first spouse to die. In a joint trust, the A Trust is most often referred to as the Survivor’s Trust. The B Trust goes by many different names – Family Trust, Bypass Trust, Exemption Trust, and Credit Shelter Trust being among the most common.
Take, for example, the case of Bill and Mary Jones, who had a joint estate of $5 million in 2009. The estate tax exclusion was $3.5 million in 2009. If Bill had died in 2009 and had left everything to Mary, because of the unlimited marital deduction and the fact that Bill’s share of the estate was $2.5 million, there would have been no estate tax at Bill’s death. However, after Bill’s death, Mary would have had an estate of $5 million, leaving $1.5 million ($5 million minus the $3.5 million exclusion amount) of her estate subject to estate tax if she also had died in 2009. If Bill and Mary had planned ahead and had an A/B trust drafted by their estate planning attorney, Bill’s share of the estate would have been distributed to the Family (“B”) Trust and $2.5 million of Bill’s $3.5 million exclusion would have been utilized to shelter these assets from estate taxes. The remaining trust assets ($2.5 million) would have been distributed to the Survivor’s (“A”) Trust. Since it was her share of the trust assets, Mary would have had unconditional access to the assets of the Survivor’s Trust. If desired, Mary could have been given access to all of the income from the Family Trust, and distributions of principal for her health, to maintain her lifestyle, and to finance her education or that of Bill’s descendants. Upon Mary’s death, only the assets remaining in the Survivor’s Trust would have been subject to estate tax, as the Family Trust assets were sheltered by Bill’s exemption amount at his death. By engaging an estate planning attorney to provide them with an A/B Trust, Bill and Mary’s descendants would have avoided having to pay the estate taxes on the $1.5 million that was unsheltered under the first example. In 2009, the savings would have been $675,000.
In 2010, the estate tax was repealed until December 17. On that date, Congress reinstated the estate tax for estates of $5 million. Congress also, for the first time, made “portability” available to the surviving spouse. With portability, the surviving spouse can add the deceased spouse’s unused exemption amount (referred to as the “DSUEA”) to his or her estate tax exclusion amount. This means a married couple could potentially maximize their estate tax savings without having to have an A/B Trust or A/B/C Trust prepared or administer two or three trusts after the death of the first spouse to die. There are many reasons, including potential remarriage protection, asset protection, state and federal income tax savings, and estate and GST tax savings, why a married couple would still want to seek the assistance of an estate planning lawyer in drafting an A/B or A/B/C Trust, but that discussion is beyond the topic of this Alert.
In order to elect portability, an estate tax return must be filed at the death of the first spouse to die, even if no estate tax is owed. Since 2010, many surviving spouses have elected not to file an estate tax return because he or she assumed no estate tax would be due at his or her death. For many surviving spouses, this assumption will prove to be true. But, for some surviving spouses, not filing an estate tax return and electing portability could prove quite costly.
Take, for example, John and Sally, who have a joint net worth of $6 million dollars. John and Sally have done no planning with an estate planning attorney, so they have no Trust in place. They own all their assets as joint tenants. Sally dies in 2011 and John gets everything due to the joint tenancy ownership. John does not file an estate tax return for Sally and, therefore, has not elected portability of her unused estate tax exclusion amount. In 2014, John dies, still owning the $6 million. In 2014, John can pass $5.34 million free of estate tax. Anything over that amount is subject to an estate tax at a 40% federal rate. Depending in what state John and Sally resided, their estate also could be subject to state estate tax or inheritance tax. As such, John’s estate is subject to a minimum of $264,000 federal estate tax ($6 million – $5.34 million = $660,000 x 40% = $264,000) that could have been avoided had John filed an estate return and elected portability of his wife’s exemption amount. Since it is too late to timely file an estate tax return (no more than fifteen months from date of Sally’s death, with extension), there is nothing John’s heirs can do but pay the estate tax.
There is a limited opportunity to fix this problem thanks to the issuance of Treasury Procedure 2014-18 by the IRS. For executors of estates of predeceasing spouses who passed away in 2011, 2012, or 2013, there is a window of opportunity until the end of 2014 to file an estate tax return (Form 706) electing portability of the deceased spouse’s DSUEA. The deceased spouse must have been a citizen or resident of the United States and the executor must not have been required to file an estate tax return. In other words, the deceased spouse’s assets must have been less than his or her unused lifetime estate tax exclusion amount ($5 million in 2011 and 2012, $5,120,000 in 2013). The 706 return must be prepared in accordance with Treasury Regulation § 20.2010-2T(a)(7) and must have the following language included at the top of the return: “FILED PURSUANT TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER § 2010(c)(5(A).” Surviving spouses and executors who wish to take advantage of this limited time opportunity should immediately consult with a qualified estate planning attorney.
(NOTE: This relief may, in part, have been triggered by the United States Supreme Court decision in United States v. Windsor, 570 U.S. 12, 133 S. Ct. 2675 (2013). Windsor involved the surviving spouse of a same-sex couple who tried to take an estate tax marital deduction on her pre-deceasing spouse’s estate tax return. In Windsor, the Supreme Court declared Section 3 of the federal Defense of Marriage Act (“DOMA”) unconstitutional. Now same-sex couples enjoy the same federal tax benefits as traditional married couples. As the result of that decision and Revenue Procedure 2014-18, same-sex married couples of which one spouse died in 2011, 2012, or 2013 will be able to file a Form 706 to take advantage of portability, even if they have not timely filed an estate tax return for the decedent spouse.)
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