The tax act signed into law on December 17 raised the federal estate tax exemption (or "coupon" amount) to $5 million per person. It also includes a provision that enables a surviving spouse to use a predeceased spouse's unused coupon amount. Though the term does not appear in the law, estate planners are referring to this as “portability.”
The law doesn’t change the fact that you can give an unlimited amount to your spouse, during life or through your estate plan (provided he or she is a U.S. citizen) with no estate tax. But until now, without proper planning, when the second spouse died, everything above the coupon amount would be subject to federal estate tax. So if Husband and Wife owned everything jointly, surviving spouse would get everthing free of estate tax, but when surviving spouse died, only the surviving spouse's coupon amount could pass tax free. The coupon of the first spouse to die would be lost. Bypass trusts (aka “credit shelter trusts”) were commonly used to address this issue. “Portability” now makes the bypass trust unnecessary for estate tax purposes, though there may still be compelling reasons to use them. And remember that the new law applies in 2011 and 2012, and after that, all bets are off. Congress will have to act again before portability becomes permanent.
Note that 15 states (including Hawaii) and the District of Columbia still have their own estate taxes, and most have exemptions of $1 million or less. Hawaii's exemption works out to $3.6 million. None of the state estate tax laws currently have any “portability” provisions. )
Forbes recently ran a list of Frequently Asked Questions regarding “portability.” Here are a few of the highlights. Read their article for a complete list.
- Does this provision help me if my spouse died years ago? No. It applies only to deaths after Dec. 31, 2010 and before December 31, 2012.
- Does portability apply to lifetime gifts as well as assets that pass through an estate plan? Yes. Under the new law, starting in 2011, the lifetime exemption and the estate tax exemption are expressed as a total amount, and it is possible to use this "unified credit" to transfer assets at either stage or a combination of the two. (From 2004 to 2010, the two amounts were different; the gift tax exemption remained at $1 million, while the estate tax exemption went up.)
- Is portability automatic? No. The executor handling the estate of the spouse who died will need to transfer the unused exemption 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 due.
- What happens if you remarry? This is where things may get complicated. The law clearly indicates that if, for example, Sally remarries after Harry's death, she can no longer use Harry's unused exemption amount–only the one of her new husband (call him Joe), assuming she survives him too. If Joe's unused exemption is less than Harry's (or if he has no unused exemption at all), Sally is out of luck.
- Is portability here to stay? Along with all the other estate tax rules in the new law, this provision is set to expire on December 31, 2012.
The bottom line is that you should not get lulled into a false sense of security that Congress has now solved all of our estate tax planning woes. Portability is a good idea as far as it goes, but it is not a panacea. For example, it does nothing for those who want to provide creditor protection for the assets they leave behind for a surviving spouse and/or descendants.