Understanding The Estate Exemption

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It is often said that the only two certainties in life are death and taxes. The IRS takes that truism to heart in most of its policies. It is especially applicable when it comes to estate taxes. The government uses estate tax law to confiscate already-taxed money from grieving heirs for little meaningful revenue gain. There is no reason death should be a taxable event. If the government abolished these taxes, it would save people money and grief.

America has always been known as a land of opportunity where you can pull yourself up by your own proverbial bootstraps. However, somewhere along the way, pulling yourself up in this inefficient way became the only socially acceptable way to stand.

People seem to lose their compassion when money is inherited. They forget that you can only inherit from your parents if they die and leave you an orphan. In many cases, the term “trust fund kid” is just another way of describing a beloved child, now an orphan.

Before we die, we have the opportunity to leave any of our possessions to anyone we choose. It is our right to choose where it goes. No matter who we choose, the heir doesn’t deserve it. Inheritance is always an act of grace.

When Oliver Twist inherits a fortune, we see the grace in it and rejoice. Alas, when the children of successful businesses inherit fortunes, many of us turn jealous or even enraged. This jealousy is used to justify the punitive estate tax with rates at 40% and the Generation-Skipping Transfer Tax raising the cost of gifts to grandchildren to 96%. At such high rates, the estate tax imperils the very existence of any family held farm or business. Furthermore, the shenanigans used to avoid the estate tax are inefficient and economically devastating.

At 31 pages in length, the Estate Tax return is daunting. It is filled with cross-referenced fields and requires you to switch between the various sections of the form to correctly complete it. It is difficult and confusing at any time, but it is particularly onerous when you are grieving. It requires acquiring valuations for illiquid valuables and creating a massive net worth statement for the decedent. If you are the child or a friend, this process is made harder by the fact that you may have never been privy to the decedent’s finances before this moment.

Luckily, many estates do not require the estate tax return. A filing is only required for estates with combined gross assets and prior taxable gifts exceeding the estate exemption for the year of death.

In 2018, the estate exemption was increased to over eleven million dollars. Now in 2019, the estate exemption is $11,400,000. On the estate tax return, this amount is utilized in calculating the “exclusion amount,” which is the amount of the estate value excluded from taxation. This is calculated on Form 706 Part 2 Line 9.

There is an effectively unlimited estate exemption between spouses who are both U.S. citizens. This is normally phrased as the first spouse to die receives “an unlimited marital deduction.” This amount is reported and calculated on Form 706 Schedule M, the “Bequests, etc., to Surviving Spouse.”

It is also possible for the surviving spouse to use the estate exemption of their deceased spouse. This is called the “portability” of a spouse’s estate tax exemption. This can effectively make the surviving spouse’s estate exemption close to $22.8 million. To preserve the portability of a deceased spouse’s exemption, you must file an estate tax return after the death of the first spouse even if you otherwise did not have to do so.

As the IRS describes it, “Beginning January 1, 2011, estates of decedents survived by a spouse may elect to pass any of the decedent’s unused exemption to the surviving spouse. This election is made on a timely filed estate tax return for the decedent with a surviving spouse.” This is done on Form 706 Part 6, “Portability of Deceased Spousal Unused Exclusion (DSUE).”

The due date of the estate tax return is nine months after the decedent’s date of death. You can get a six month extension by filing Form 4768.

If an estate has tried to reserve the unused exclusion of more than one deceased spouse, then that surviving spouse’s estate may only use the most recent deceased spouse’s DSUE. This means if you remarry and your new spouse dies first, you would lose your previous spouse’s exclusion and acquire your new now deceased spouse’s one instead. However, if you remarry and are the first to die from among that new marriage, then your first spouse is still the most recent deceased spouse. As a result, that DSUE is still preserved from the first marriage.

For this reason, remarriage can be a complicated tax planning issue. If you do choose to remarry, one strategy to utilize your previous spouse’s estate exemption is to apply the DSUE of your first spouse to lifetime gifts, rather than saving it for death.

Historically, the estate tax exemption has been much lower. Prior to 2018, the individual exemption has been around $5 million for several years. Prior to 2008, it was closer to $2 million. Right now, heirs are benefiting from the high individual exemption of $11.4 million. However, those of us who are younger should not count on the high exemption to still be there for us when our heirs need it. Smart estate planning now is always beneficial. Some estate tax saving strategies require diligence over the course of several years in order to be beneficial.

Without planning ahead and with the burden of gift, capital gains, and estate taxes, there is no real strategy, short of having extra piles of money just to pay taxes, for a family business to get passed down to the next generation. And yet there is no reason to believe that confiscating that wealth for government spending is morally superior.

Photo by Dylan Nolte on Unsplash

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Chief Operating Officer, CFP®, APMA®

Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. She is the author of over 800 financial articles and is known for her expertise on tax planning.