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Estate Tax, Portability and the New Tax Law

The new tax law is on the books, and among its many changes is a doubling of the estate tax exemption amount from $5.49 million for an individual ($10.98 million for married couples) to around $11 million for an individual (around $22 million for married couples). This means little to ordinary Americans whose estates are valued well under a few million dollars (the vast majority of my clients – oh, and me too). However, for those flirting with the five-or-so million dollar mark and considering whether to plan to reduce the size of their estate (or married couples flirting with the eleven-or-so million dollar mark), the new tax law and doubled exclusion amounts mean you may be safe from having to engage in advanced planning techniques.

Estate Tax—Still a Valid Concern

However, for individuals and couples whose estates may be flirting with (or are certainly in excess of) the new exclusion amounts in the tax bill now headed to the white house, the estate tax remains a real and valid concern. After all, Uncle Sam still takes 40% (!) of the excess value of the estate-- that is, 40% of the value of the estate which is in excess of the exclusion amount. If an individual’s taxable estate is valued at $20 million, and the exclusion amount is $11 million, your executor would be writing Uncle Sam a $3.6 million check.

Taking Advantage of the Exemption Amount for Married Couples

It’s a relief for married couples with significant assets to know that they can effectively use both of their individual exemptions. However, the popular understanding that this happens automatically is incorrect because something called the “unlimited marital deduction” often gets in the way. Basically, it works like this: when the first spouse dies, assets passing to the surviving spouse (often all of the decedent’s assets), pass estate-tax-free by way of the unlimited marital deduction. This sounds great, but the problem is that the unlimited marital deduction cannot be waived, and assets passing by way of the unlimited marital deduction do not utilize the first spouse’s estate tax exemption amount. As such, the first spouse’s exclusion amount is lost, and all the surviving spouse has to work with is his or her individual exclusion amount.

Enter “portability.” Portability allows the first spouse to die to transfer his or her unused exclusion amount to the surviving spouse. However, portability is fragile and lost under certain circumstances (such as divorce), so many attorneys prefer to utilize planning techniques that ensure that the first spouse to die transfers an amount equal to their estate tax exemption amount to a trust for the benefit of the surviving spouse, rather than to the surviving spouse directly.

Opportunity Lost

If you’re following this, you’re doing better than most, and the reality is that for most people the estate tax discussion is moot because their estate is nowhere near the now $11 million threshold.

But, politics aside, there was a real opportunity here for congress to simplify the bizarre and complex estate tax laws currently on the books. And the explanation above only scratches the surface of the estate tax, and covers nothing at all of the even-more-baffling Generation Skipping Transfer Tax.

Traditionally, to ensure that the surviving spouse has access the first spouse’s unused exemption amount, attorneys draft bypass trusts or disclaimer trusts which are expensive and which the clients themselves have little shot at understanding. And the cost doesn’t end at the drafting of these trusts, because when the first spouse dies, the second spouse likely has no recollection of what these documents are or why they exist (if their attorney even offered a comprehensible explanation at the time of drafting, which is no easy feat). So, the surviving spouse, at what is already a difficult time, must hire an attorney to help them sort it out.

So, while this tax bill was originally touted as a simplification of the tax code and is anything but, at least the doubling of the estate tax exemption amount reduces complexity in the sense that fewer individuals will need to engage in complex and costly estate planning.

If you have questions about the estate tax, your estate plan (or lack thereof), or the process of probating the estate of a deceased loved one in Pennsylvania, please don’t hesitate to get in touch. Consultations are always free.

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