The 2010 tax law gives married couples a wonderful new tax break. Many will lose it because they don't know how to use it.
Here’s what I mean: for the next two years we can each transfer up to $5 million tax-free during life or at death. That figure is called the basic exclusion amount. Starting in 2011, widows and widowers can add any unused exclusion of the spouse who died most recently to their own. This dramatic change enables them together to transfer up to $10 million tax-free.
Still, portability, as tax geeks call it, is not automatic. The executor handling the estate of the spouse who died will need to transfer the unused exclusion to the survivor, who can then use it to make lifetime gifts or pass assets through his or her estate. The prerequisite is filing an estate tax return when the first spouse dies, even if no tax is owed. Let's hope that the Internal Revenue Service develops a short form for the purpose.
This return is due nine months after death with a six-month extension allowed. If the executor doesn't file the return or misses the deadline, the spouse loses the right to portability. Spouses should file it even if they're not wealthy today, because who knows what the future holds? (For questions and answers on the new $10 million per couple federal estate tax break, click here.)
I’m on a public service campaign to educate people about the looming nine-month deadline so they don't miss it. Still, I'm afraid this will be a new trap for the unwary. It's not something most of us think about when we (and our spouses) are healthy and hearty. At a time of grief, it's one more thing to think about, and could fall through the cracks. This risk is probably greatest for the growing number of people who decide to save money and bypass lawyers during the process of estate administration: submitting the will for a court's approval and distributing assets to inheritors.
Financial advisers, who are likely to be in touch with clients who have lost a spouse, provide an enormous value-added by reminding widows and widowers to make sure an estate tax return is filed. That's true whether or not a adviser plays a role personally in preparing the federal estate tax return.
There is another time when portability is relevant. It involves large lifetime gifts, a subject that interests far fewer people, especially in light of the latest economic crisis.
Starting in 2011, the tax-free amounts available during life and at death are expressed as a total, and it is possible to use this $5 million exclusion to transfer assets at either stage or a combination of the two. The IRS expects you to keep a running tally and report these gifts so it will know how much has already been used up when you die. For example, if you have used $1 million of the exclusion to make taxable lifetime gifts, the unused exclusion when you die will be $4 million, rather than $5 million.
Here too, couples get a special break: they can share the basic exclusion during life (this process is called gift-splitting) and give more to the kids now, tax-free. But of course this also reduces how much of the tax-free amount will be available when they die, either for their own use or to be carried over by the survivor.
Now that spouses can share each other’s $5 million exclusion amount--either through lifetime gifts or bequests--this is also something to keep in mind if you remarry.
When one of the couple is wealthy, and the other enters the marriage with an unneeded $5 million exclusion, they might agree on an arrangement to combine the two exclusion amounts for lifetime gifts so that the wealthier spouse can give more to her kids tax-free. Warning: don’t give up your tax dowry without legal advice, and make sure it comes from your own lawyer--not one your spouse hired. More about that in my article, “Estate Planning For Women (And The Men Who Love Them).”