Certainty

Affluent families everywhere should have heaved a sigh of relief when Congress averted the fiscal cliff as 2013 began. Failure would have meant a return to a $1 million federal estate tax exemption and a 55% tax rate, exposing millions more families to this tax.

Estate planners heaved a sigh of relief for an entirely different reason. For the first time since 2001, we now have a stable, permanent federal estate tax exemption. No more phase-ins, no more wills and trusts drafted in contemplation of scheduled tax changes. The amount of the exemption was left unchanged, $5 million plus adjustments for inflation since 2010. The tax rate was lifted from 35% to 40%. With plain vanilla estate planning strategies, a married couple will not need to worry about federal estate taxes until the family fortune exceeds $10 million.

In fact, even without estate planning married couples can achieve that outcome. An estate planning rule adopted temporarily in 2010 was made permanent.

DSUEA

The essential objective is that for estate tax purposes, married couples should be treated as a single economic unit, each entitled to a federal estate tax exemption. In the past, such treatment was not automatic.

Example. John’s will left his entire $8 million estate to his wife, Mary. No federal estate tax would be due, because the marital deduction for such estate transfers has no dollar limit. However, at Mary’s later death, her exemption of $5 million would leave $3 million exposed to taxation, at a cost of upward of $1 million.

The “plain vanilla” estate plan for avoiding this tax was to split John’s estate into two trusts, to take advantage of his estate tax exemption, rather than the marital deduction, to reduce taxes to zero at his death. A “credit shelter trust” would entirely avoid taxation at the death of the surviving spouse.

The new tax rule created something called the “deceased spousal unused exempt amount,” or DSUEA. In a nutshell, the federal estate tax exemption became inheritable between spouses. To the extent that the estate of the first spouse to die fails to take advantage of an available exemption, the estate of the second spouse may claim it. To preserve the DSUEA, an estate tax return will need to be filed for the first spouse to die. To continue the example, if the executor of John’s estate files the estate tax return for him, even though no tax will be due, Mary’s estate will be entitled to a maximum exemption of $10 million. (Inflation has been ignored in this example.)

When the DSUEA was introduced in 2010, estate planners urged caution, because the provision was slated to expire at the end of 2012. There was no guarantee that a DSUEA created in 2011 or 2012 still would be valid in later years. Now this uncertainty has been removed.

Estate planners may continue to recommend credit shelter trusts in some cases. The trust offers the added advantage of avoiding estate taxes on asset appreciation that occurs after the first spouse dies. Trust plans may also offer investment management advantages that many families will find attractive.

(January 2013)