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Fewer than 3,300 estates will owe federal estate tax this year, the smallest number in more than 75 years (other than 2010 when the tax disappeared for the year). But, paradoxically, even as Congress shrinks the number of taxable estates, the law also encourages many more estates to file returns—even if they owe no tax. That will increase costs to those who want to do prudent estate planning, keep their planners and lawyers busy, and swamp the IRS with many times the number of returns filed in recent years.
The reason: the portability provision in the 2010 Tax Relief Unemployment Insurance Reauthorization and Job Creation Act that allows surviving spouses to claim on their own estate tax returns any exemption not used by their spouses. The 2011 exemption is $5 million. If a husband dies this year and leaves an estate with a taxable value of $3 million, his estate owes no tax and his wife’s estate may claim the unused $2 million exemption when she dies. Thus, if the $5 million exemption remains in effect, her estate could avoid tax on its first $7 million.
Portability—that is, retaining that unused exemption—has its price, though: A surviving spouse must file an estate tax return that specifically provides for portability on time, whether or not the estate owes any tax. Otherwise, the extra exemption is lost forever. (And, curiously, the decedent or the executor may specifically deny portability on the return, thus making it unavailable to the surviving spouse.)
Filing such a return is a no-brainer for couples with large estates that are close to the current $10 million combined tax threshold. Preserving the unused exemption will save future taxes if the survivor’s estate grows past the amount of an individual exemption.
But many smaller estates could also benefit from holding on to the unused exemption. In 2013, the estate tax is scheduled to revert to its pre-2001 form with a $1 million exemption and a 55 percent top tax rate. President Obama and Congress may not allow that to happen but might adopt an exemption below $5 million. For example, the president has repeatedly proposed reverting to the 2009 estate tax parameters: a $3.5 million exemption and a 45 percent tax rate. Having a spouse’s unused exemption available could save the survivor’s estate hundreds of thousands of dollars.
Of course, Congress also could take away the unused exemption in future estate tax legislation. Estates would undoubtedly challenge that change in court and might or might not win. But without keeping the portability option open, they’d clearly have no case.
I suspect that estate tax attorneys are hard at work, explaining to their clients the benefit to filing an estate tax return even if the law doesn’t require one. The nine-months-after-death deadline for filing returns has already expired for people who died early this year and more estates miss the deadline each day.
How many and by how much surviving spouses will benefit from portability is uncertain. What is sure, however, is that the IRS will have to process a lot more returns and attorneys will have a lot more business preparing them.
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