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Estate Planning with Portability Part I

Published December 3, 2014 by Brady Cobin Law Group, PLLC

The American Taxpayer Relief Act of 2012 made “permanent” the concept of portability. The use of portability in estate planning has changed how planning is done for many married couples. This is the first of three articles on portability in estate planning. These articles are of particular relevance to married couples who either have no estate planning in place, or who have not updated their estate plans since 2010. In part I, we’ll gain an understanding of federal estate taxes. In part II, we’ll look at both traditional planning approaches as well as the use of portability in estate tax planning. And finally in part III, we’ll examine the pros and cons of portability as compared to the traditional approach to eliminating estate taxes.

As a starting point, to understand how estate planning can be used to minimize estate taxes there are two concepts to be familiar with. The first concept is the Federal Estate Tax Exemption amount. The Federal Estate Tax Exemption amount is the amount of any estate that can be passed free of taxes. The current Federal Estate Tax Exemption amount is $5 million ($5.34 million, as indexed for inflation for individuals dying in 2014). Amounts above $5 million are taxed at a rate of 40%.

It’s helpful to envision the Federal Estate Tax Exemption as a coupon. In other words, imagine at death your estate must pay the Fed 40% of its value. However, each of us has a coupon that can be applied against the first $5 million of the estate that will pass tax free.

The second is the concept of the Unlimited Marital Deduction. Under the Unlimited Marital Deduction there is no estate tax due on assets transferred from a deceased spouse to his surviving spouse.

Have you spotted the issue that can be created in using the Unlimited Marital Deduction in conjunction with the Federal Estate Tax Coupon when planning for married couples? It’s a matter of creating a tax issue at the second death by failing to use a coupon at the first death. Let’s give an example:

In our example we have a family of four: husband and wife Bob and Sara, and their two children Jake and Desiree. Bob and Sara’s combined net worth is $6 million, and for simplicity sake, we’ll say that each is worth $3 million. Bob passes away and leaves all of his estate to Sara. Because the transfer of Bob’s estate was to his spouse, the Unlimited Marital Deduction applied, and no federal estate tax was due.

A couple of years later, Sara passes away. She leaves everything to Jake and Desiree. Her estate is valued at $6 million. She has a $5 million coupon to apply, which means that $1 million of her estate is subject to federal estate taxes. At a rate of 40%, $400,000 of Jake and Desiree’s inheritance goes to the Federal Government.

In part II, we’ll examine traditional methods of estate planning in helping Jake and Desiree avoid this $400,000 disinheritance. We’ll also examine how portability may be used as an alternative. If you’d like to learn more or to speak with an estate planning attorney about your situation, contact Brady | Cobin Law Group, PLLC your Raleigh Estate Planning Attorney for an initial consult – (919) 825-1518.

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