Simple and Sophisticated Estate Tax Planning for Spouses

Whether you have an elaborate estate plan or a list of ideas on a napkin, your plan could likely use an update, because the way estates are taxed has changed drastically in the last five years. Married couples now have four major tools that can be used to avoid the burden of federal estate taxes: deduction, portability, gifts, and disclaimer.

Unlimited Marital Deduction: Transfers between spouses are generally not subject to estate or gift tax. The Internal Revenue Code allows for transfers of assets between spouses without tax consequences. Spouses can strategically move assets to keep either spouse from having more than the federal estate tax exemption amount. The individual amount is now $5 million, indexed for inflation. If the estate of one spouse is nearing that amount, he can simply transfer assets to his wife to make sure that his estate won’t be subject to federal estate tax upon his death.

Spousal Estate Tax Exemption Portability: “Spousal portability” allows married couples to combine their federal estate tax exemption amounts to give the couple, as a unit, a $10 million exemption, indexed for inflation. This means that one spouse could die with nothing to his name and his surviving wife could transfer $10 million free of estate tax when she dies, using her own and his $5 million estate tax exemptions. There’s one important caveat: portability of the first deceased spouse’s unused exemption amount expires if the surviving spouse remarries and outlives the second spouse. If a wife dies, leaving $2 million to her kids and her husband remarries and his second wife dies before him, he can no longer use his first wife’s left over $3 million exemption; his tax exemption amount is the unused exemption amount of his second spouse.

Inter Vivos Gifts: Inter vivos gifting is “legalese” for giving things away while you are alive. By giving away assets during lifetime, you can keep your estate below the federal estate tax exemption amount and benefit your loved ones early! This concept is not limited to spouses as are the other three tools; it can be a tool for anybody with a large estate. For couples whose combined assets total more than $10 million, inter vivos gifting can be very effective.

There are two considerations: (1) income tax, and (2) gift tax. The income tax consideration is for the recipients (“donees”) of the gift. They pay no income tax when they receive the gift, at the federal level or in New Hampshire, but when they sell the asset, the capital gains taxes are calculated on the difference between the donor’s cost basis and the sale price. So if Grandma gives Junior $10,000 in GE stock she has held for 60 years and then he sells it, there will be a big capital gains tax owed by Junior on that sale. (The rule is different for transfers at death: the donee’s cost basis is “stepped up” to the value on the date of the donor’s death).

The gift tax consideration is for the donor: any gifts over the annual exclusion amount of $14,000, to each donee, are subject to federal gift tax (and in some states also state gift tax), although no gift tax is owed until the donor has used up the donor’s entire estate and gift tax exemption, which combined are $5 million, indexed for inflation, at the federal level, over a lifetime and at death.

Any gift over the annual exclusion amount (currently $14,000 per donee) triggers the need for the donor to file a gift tax return, even if no gift tax is due. The IRS wants to keep track.

Strategic gifting requires a long term plan. For example, gifting $1 million to your three children, tax free, will take over 20 years! Make sure to plan ahead and consider setting up trusts if you don’t want your beneficiaries to receive the entire $14,000 outright, each year.

Disclaimer Planning: Disclaimer planning is a way for spouses with large estates to avoid or mitigate federal estate tax while also keeping some flexibility in their estate plan. It involves setting up several trusts in a way that lets the surviving spouse make key decisions when the first spouse passes away. Disclaimer planning capitalizes on the benefits of the previous three doctrines but requires careful planning with an estate planning attorney and accountant.

The Bottom Line: Any estate requiring tax planning requires careful planning and strategizing so it is always a good idea to consult with an attorney. DTC Lawyers, with offices in Meredith, Exeter and Portsmouth NH, has estate planning attorneys ready to assist clients with making the most of these tax advantages in a modern and cohesive estate plan.