It is important to understand the role of the marital deduction in your estate to make sure that both you and your spouse take full advantage of the estate tax credit that each of you are entitled to.
There are no limits on how much of a marital deduction your estate can qualify for. Thus, if your entire estate goes to your surviving spouse, your estate will owe no federal estate tax. Many taxpayers take this simple approach.
The American Taxpayer Relief Act of 2012 permanently provides for a maximum federal estate rate of 40% with an annually inflation-adjusted $5 million exclusion for estates of decedents dying after December 31, 2012.
The 2012 American Taxpayer Relief Act allows the maximum exclusion amount to be shared between spouses. In general, a surviving spouse may increase their exclusion amount by electing to take the unused portion of the estate tax exclusion of his or deceased spouse. The deceased spouse’s exclusion amount would be available indefinitely.
In total, with careful estate planning, a married couple could exclude up to $10 million from estate tax under the new law. If the surviving spouse has more than one deceased spouse, the exclusion amount is limited to the lesser of $5 million or the unused exclusion of the last deceased spouse.
Example:
John dies in 2012, has no taxable estate and made taxable transfers of $3 million. On John’s estate tax return, a voluntary election was made to allow John’s wife Cynthia to use his unused exclusion amount. At the time of John’s death, Cynthia had not made any taxable gifts. Therefore, Cynthia’s exclusion amount would be $7 million, her $5 million exclusion plus $2 million of John’s unused exclusion. Because this election is made on an estate tax return, if there is a reasonable chance that the surviving spouse will be subject to estate tax, it would be highly advisable for the estate to file an estate tax return on behalf of the deceased and assign the unused portion of the exclusion to the surviving spouse.
This new rule also means a credit shelter trust is no longer necessary for the surviving spouse to be able to use the deceased spouse’s estate exemption as part of the couple’s estate planning. However, that does not mean that a credit shelter has become obsolete. What if the estate limits fall back down to lower levels? For example, would Cynthia lose John’s $2 million excess exemption amount if the estate tax limits were to fall to (or even below) the $3 million that John already used? Tax practitioners do not know the answer to that. A credit shelter trust would “lock in” John’s $5 million exclusion permanently. Also, with blended families, you may not want all of your assets and the unused exclusion to pass to your spouse because they are not the parent of your children. It would be wise to give some assets from your estate directly to your children.
While the new rules were probably intended to simplify estate planning by allowing a spouse to pass their unused exclusion to their surviving spouse, that has not necessarily turned out to be the case. When discussing the complexities of estate planning, our recommendation is to always speak with an estate planning attorney, as well as your Tax Consultant.
If you would life further information regarding this topic or any other tax related issue, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.