Dear Mr. Premack: My father’s estate value is approximately $350,000, and my mother’s is approximately $650,000. Father passed away in April 2012 and mother inherits his property, so she will have estate of approximately $1,000,000. She is healthy and we hope to have many more years with her. We believe her estate value will increase over time because it is mostly valuable real estate. Although my father’s estate has no taxes due, should we file in order for my mother to make the election to use any unused exemption of her husband’s estate tax? We are not sure if there is any downside or reason not to file for the deceased spousal unused exclusion amount. – R.S.
The answer to your question depends on accurately predicting what Congress will decide about future federal estate tax exemption rates. You may know the history: Before year 2000, the federal estate tax was imposed on all estates larger than $675,000. The tax rate was 50%, so many people went through complex tax planning to reduce or eliminate the estate tax. The Bush law increased the exemption to $3.5 million by 2009 and set it to expire at the end of 2010. In late 2010 Congress and Obama authorized a new, two year $5 million exemption. Now, Congress will either pass new exemption rates for 2013 or will refuse to do so. Inaction will drop the exemption to about $1 million, which is the risk your mother seeks to avoid by claiming your father’s unused $5 million exemption.
Allowing the surviving spouse to accumulate the deceased spouse’s unused exemption (called portability of the exemption) was new with Obama exemption law. Prior to portability, this same concept could be achieved with proper tax planning (often called bypass planning) which utilized a trust to avoid wasting the deceased spouse’s exemption. No trust is needed to use portability. Instead, the IRS requires the surviving spouse to file an estate tax return for the decedent, and in that return to elect portability.
Here’s an example: Greg and Lori were married for many years and saved $6 million, all community property. Greg died in 2012 and his Will left his half to Lori. The devise to her is tax-free under the “unlimited marital deduction” so his $5 million exemption is never used. Lori now has $6 million with her exemption of $5 million. When she dies, the extra $1 million will be subject to federal estate tax.
To use portability, Lori can file an estate tax return on Greg’s estate (an otherwise unnecessary action because he owed no tax and was not required to file a return). She elects to have his $5 million exemption accumulated with her $5 million exemption. When Lori makes Greg’s exemption portable, she has a $10 million exemption if she dies in 2012. If she dies in 2013 (so her personal exemption is just $1 million) she still gets to use Greg’s $5 million exemption. When she dies, her $6 million estate is totally tax free because the dual exemptions eliminate the tax.
Now to your parents. Since your father left everything to your mother, there is no estate tax due upon his death. No return is required. But your mother will have an estate of $1 million which should grow larger over time. She is not expected to die in 2012. Accurately predicting the future is beyond our powers; we do not know what exemption she will have when she dies. The worst case scenario is that she will have a $1 million exemption (if Congress fails to pass a new exemption rate before 2013).
She can control whether to file or not file the return. She cannot control what action Congress will take. Those factors lead to four possible outcomes. Her choice of actions will dictate the outcome, and her choice will depend on her risk tolerance:
She files, then Congress later passes a new exemption rate. She did not gamble, but filing the return was a waste of time and money. The new exemption eliminates the tax.
She files, then Congress later fails to pass a new exemption. She did not gamble. The return was needed so that she had portability. Portability eliminates the tax.
She does not file, then Congress later passes a new exemption rate. Her gamble wins. She spent no money on filing the return and the new exemption eliminates the tax.
She does not file, then Congress later fails to pass a new exemption. Her gamble loses. The money she saved by not filing is tiny compared to the estate tax that will be due when she dies.
In addition to working with her CPA on the tax issue, she should see a certified Elder Law attorney to probate your father’s Will and to review her own estate plan now that she is widowed.
Paul Premack is a Certified Elder Law Attorney and a Five Star Wealth Manager (Texas Monthly Magazine 2009-2012) practicing estate planning and probate law in San Antonio.
Original Publication: San Antonio Express News, August 27, 2012