One of the most common reasons people give for creating a comprehensive estate plan is the desire to ensure their assets will be passed down to loved ones after they are gone. If that is one of your estate planning goals, you clearly want to pass down as much as possible to your family and loved ones to ensure that they are well provided for after you are gone. Simply amassing a large estate is not sufficient to ensure your goal is met because without careful planning your estate could lose a significant percentage of its value to federal gift and estate taxes at the last minute. If you are married, you need to have a firm understanding of how the estate tax works for married couples to maximize the estate you leave behind.
What Is the Federal Gift and Estate Tax?
The federal gift and estate tax is essentially a tax on the transfer of wealth. The federal government wants to make sure that when wealth passes from one generation to the next it is properly taxed. The best way to do that is to tax the transfer at the time it occurs. Gift and estate taxes are potentially owed on the value of your estate assets owned at the time of your death combined with the value of all lifetime gifts made by your prior to your death. For instance, if you made gifts over the course of your lifetime valued at $4 million and left behind an estate valued at $8 million, the combined total of $12 million could potentially be subject to federal gift and estate tax.
The Unlimited Marital Deduction
People often make the mistake of relying on the unlimited marital deduction as an estate planning measure. Although it can be used when necessary to avoid estate taxes, it often creates a worse tax situation for the surviving spouse. The unlimited marital allows you to leave an unlimited amount of assets to your spouse when you die tax-free. The problem is that you often over-fund your spouse’s estate by using the marital deduction. Imagine, for instance, that your spouse has separate assets valued at an additional $3 million. By leaving him/her your $8 million in assets your spouse now has a taxable estate valued at $11 million. You have not actually avoided paying estate taxes, just delayed doing so.
The Lifetime Exemption
Every taxpayer is entitled to exempt up to the current lifetime exemption limit. Historically this figure fluctuated frequently and significantly. Thanks to the American Taxpayer Relief Act (ATRA) of 2012, the lifetime exemption limit was permanently set at $5 million, adjusted annually for inflation. For 2016, the lifetime exemption limit is $5.45 million, meaning that a taxpayer can exempt up to that amount from his/her estate before gift and estate taxes are levied. In our example, you would be able to exempt $5.45 million from your $12 million estate, leaving a taxable estate of $6.55 million that would be taxed at a tax rate of 40 percent.
What Is Portability?
Portability refers to the ability of a surviving spouse to make use of the unused portion of a deceased spouse’s lifetime exemption. By way of illustration, portability works like this:
Both you and your spouse are entitled to an exemption of $5.45 million. That means a married couple could exempt up to $10.9 million in assets. Assume, however, that instead of you dying first, your spouse predeceases you. At the time of his/her death he/she only needed to use $3 million of the allowable $5.45 million. The remaining $2.45 million will then “port” over to you, increasing your lifetime exemption limit to $7.9 million. ($5.45 + $2.45 = $7.9 million) Upon your death, you would then be entitled to exempt $7.9 million instead of $5.45 million, reducing your taxable estate from $6.55 million to $4.1 million.
The key to reducing your gift and estate tax liability is to work closely with an experienced North Carolina estate planning attorney to create a comprehensive estate plan that incorporates tax avoidance strategies into your plan.
For additional information, please join us for one of our upcoming free seminars. If you have additional questions about how the federal gift and estate tax impacts married couples, contact the experienced estate planning attorneys at The Law Offices of Cheryl David by calling 336-547-9999 to schedule an appointment.