The Issue of Portabilty

The proposed budget our President presented to Congress this week includes raising taxes on the highest U.S. income earners as well as multinational and oil and gas companies.  Leaving the issue of income taxes aside, this proposed budget brings back the discussions of 2010, proposing once again that the estate tax should return to 2009 levels with a $3.5 million individual exemption at a 45% tax rate.  In other words, our current tax rates would expire yet again at the end of 2012.

It also includes limiting itemized deductions for top earners to 28% and limiting the value of tax breaks for charitable contributions, home mortgage and state and local taxes.  Another provision of the budget involves the repeal of the tax rule that requires retirees take withdrawals from individual retirement accounts with a balance of less than $50,000 after age 70 ½.

In addition, the administration recommends that portability be made permanent.  When President Obama signed the bill in December it raised the tax-free limit on lifetime gifts from $1 million to a hefty $5 million ($10 million for couples, indexed for inflation), before estate and gift tax would apply.  This, of course, for the past two months has had the estate planning community in a quandary on whether to recommend to their clients that they give everything to their kids within the next two years to save on future estate tax.  What to do, what to do…

As of now, come 2012, the amount of this exclusion will revert back to the amount pre-EGTRA 2001 rates which was $1 million.  If Congress doesn’t act before 2012, portability will expire, the exemption goes back to a $1 million at a tax rate of 55%.  From the estate planning view, gifting has always had an advantage over passing assets at time of death.  Such gifts leave less in your estate for the government to tax and if the assets have increased in value after gifting, you do not owe gift tax on the appreciation.

Let’s take a look at what portability means should one wish to take advantage of the current law.  A surviving spouse of a person who dies after December 31, 2010, may be eligible to increase the surviving spouse’s exclusion amount by the portion of the predeceased spouse’s exclusion that remained unused at the predeceased spouse’s death. This provision allowing the portability of the predeceased spouse’s unused exemption applies through December 31, 2012. One provision of the law is that the executor of the estate of the first spouse to die must file an estate tax return, even if no tax is due.

If a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion that is available for use by such surviving spouse is limited to the unused exclusion of the last such deceased spouse to die. The surviving spouse may use his or her exclusion, augmented by such predeceased spouse’s unused exclusion, for taxable transfers made during life or at death.

Notwithstanding the statute of limitations for assessing estate or gift tax with respect to that predeceased spouse, the return of that predeceased spouse may be examined and adjusted for purposes of determining the deceased spouse’s unused exclusion amount available for use by the surviving spouse.

Pre the portability provision, estates relied on a variety of strategies created by estate planning attorneys in order to pass wealth through generations, such as GRAT’s, or re-titling assets in order to take advantage of the exclusion while minimizing the tax owed. Many in the estate planning community would like for portability to become permanent and eliminate complicated tax planning.

However, others question whether this is an opportunity at all.  Keep in mind that if Congress again decides to do nothing in 2013, this all expires. Congress could just as easily extend the current rates or repeal the estate tax altogether.  If that were the case, there would have been no reason to make these large gifts.

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