As of January 1, 2013, the American Taxpayer Relief Act permanently set the estate and gift tax exemption at $5 million (and with inflation increases to $5.25 million). The tax rate for anything above that is 40 percent. As an additional benefit, for deaths that have occurred after December 31, 2010, widows or widowers can add “any unused exclusion of the spouse who died” to their own $5.25 million tax-free amount. This enables a married couple, or a survivor, to transfer up to $10.50 million tax-free, regardless of whether a Bypass Trust has been used.
For example, if upon the death of a spouse, only $1 million of his or her $5.25 exclusion has been gifted, then $4.25 million – the unused exemption portion – can be transferred to the surviving spouse. This is called “portability”. This is a big change from the prior law. Previously, a surviving spouse would not “inherit” any unused exemption from a deceased spouse, but through a Bypass Trust could obtain limited rights to use an amount equal to the unused exemption. It all involved some complex estate planning to maximize the total combined exemption.
Portability is not automatic. It involves filing an estate tax return within 9 months after the death of the spouse even if there are no taxes due. If filing doesn’t happen before this deadline, and upon a remarriage of the surviving spouse, the inherited exemption amount may be lost if the surviving spouse’s new spouse dies first. Estate planning and proper living trust drafting is still an essential component of sound asset protection and estate planning, but the new rules may lend an additional degree of certainty to the process.