Nothing is certain in the world but death and taxes. The estate tax is the government’s way of celebrating both events at once. When you die, the state and federal governments impose a tax on the net value of your estate. That general rule is subject to many exceptions. Right now the two largest exceptions to the federal estate tax are that:
1. The transfer of property from the first spouse to die to the second is exempt from estate tax. The term of art is the “unlimited marital deduction”. When husband dies, leaving everything to wife, the entire amount of the property escapes the estate tax at the husband’s death. The theory is that the property ends up in the wife’s estate, and so is taxed once, upon her death. Otherwise, the same property would be taxed twice – at the time of each death. That is basic fairness.
2. The first $5 million of each estate is currently exempt from federal estate tax (and the term of art is the “applicable exclusion amount”). If you die with a net estate of $5 million or less, you pay no federal estate taxes. Above $5 million, you pay tax at a rate that tops out at 35%. This is the state of the law until the end of 2012, when the issue is then turned back into an election year football.
For now, if husband and wife each had $5 million in assets in their own names, then when husband dies, he could leave his $5 million estate to all of his beneficiaries (other than his wife), without paying any federal estate tax. When wife dies, her $5 million estate could go to her beneficiaries, again tax free. So, $10 million of family assets would pass tax free to the next generation. But, if you change the facts ever so slightly there, and had the husband leave his $5 million to his wife, who died the following month owning $10 million in assets, then the first $5 million would be tax free, and the second $5 million would be taxed at 35%. The estate tax would be $1,750,000. The term of art for that result is “expensive mistake”.
This does not seem quite fair that the same wealth and the same basic circumstances could be taxed so differently. Clever lawyers developed a way around that unfair result – the credit shelter trust – which gave the wife the income from the husband’s money for life – and then when she died, each estate received the maximum estate tax exclusion. If your current will is written with a credit shelter trust in place, which provides that the husband’s estate goes, not directly to the wife (and vice versa), but into trust for the benefit of the wife, and then upon her death to his heirs, then that is the reason. Tax gymnastics. Or as we attorneys prefer to call it, estate planning.
Under the most recent amendments to the federal estate tax though, a new concept has been introduced in this area: portability. Rather than forcing the husband’s estate into a trust for the surviving wife, the law now recognizes that like situations should be treated that way. When husband dies, leaving his assets to his wife (or even in the situation where all assets are jointly titled in both names and automatically pass to the wife), his estate does not need or use his $5 million exclusion. Everything passes tax free to a spouse under the unlimited marital deduction. In the past, the husband’s exclusion amount would have been lost. But amazingly, once was lost now is found, through portability. The surviving wife’s estate now gets to use the husband’s $5 million exclusion amount, plus her own exclusion amount, when she dies. As a result, $10 million in family assets escape the federal estate tax. Order reigns in the universe. Until 2013.
There is still value to the credit shelter trust arrangements. First, we don’t know what will happen in 2013, but in default of Congressional action, the rules of 2001 will be restored, and so the trust device will then be beneficial. Second, assets that are placed in trust are placed outside the reach of creditor’s claims of the wife. Third, the growth in value of appreciating assets such as stocks held by the trust, will not be subject to the estate tax – because they are not in the wife’s estate. So, there is no need to jettison your will because it has a credit shelter trust in it.
The estate tax has been constantly in flux over the last several years. The great majority of Americans are unaffected because their estates do not exceed $5 million. But, if you are over that amount, in a situation where a simple lack of a plan can cost you over a million dollars in taxes, you should seek out competent tax planning advice. Check your will, understand what your estate plan is and the results it seeks to obtain, and see your friendly neighborhood attorney if you have questions!
Doug Humes has been a practicing attorney in Pennsylvania since 1980. He has experience in real estate, community, corporate and small business law, and estate planning. In 2003, he opened his private general practice in an old mansion in Bryn Mawr, Pennsylvania. Contact him at Tel: 610-525-7150, or via email athumeslaw@verizon.net.
©2011 Douglas P. Humes
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