In my last post, I explained how the Deceased Spouse’s Unused Exclusion (DSUE) can be “inherited” by the surviving spouse, helping to shield their heirs from federal and state estate taxes that can combine to exceed a rate of 50%.
But what happens when a widow or widower with a DSUE remarries? The answer may surprise you.
Tax rules stipulate that the surviving spouse can use the DSUE of their “last deceased spouse.” That’s an important phrase to keep in mind, because some important estate planning needs to be done before either spouse passes away.
A subsequent marriage to someone to someone who dies without leaving an exclusion available can actually foil the surviving spouse’s prior estate planning. The surviving spouse would then lose the DSUE from their first deceased spouse, and would instead be left with the diminished or non-existent DSUE they “inherited” from the second deceased spouse’s estate. Consider the following example:
Arnold and Betty have been married for 40 years and have three grown children. It was a first marriage for both of them, until Arnold died in 2013 at age 60. Betty owns $10 million in assets, while Arnold left $5 million to Betty and $3 million divided among their children. The estate tax exclusion when Arnold died in 2013 was $5.25 million, and Arnold’s estate used $3 million of the exclusion to shield all of the children’s inheritance from taxation. No exclusion was needed for the assets transferred to Betty, as there is an unlimited spousal exclusion available to all taxpayers. [Note that this example assumes that neither Arnold nor Betty had made gifts during their lifetime that would reduce the unified credit.]
An estate tax return was filed and an election was made allowing Betty to benefit from the $2.25 million exemption that Arnold’s estate did not use (the DSUE). The $2.25 million carries forward as a set number even as Betty’s individual estate tax exclusion is indexed and grows with inflation. For 2015, Betty is able to shield $7.68 million in assets from estate tax (her own $5.43 million exclusion for 2015, plus the remaining $2.25 million that was unused by Arnold’s estate).
Now, suppose Betty remarries. Her second husband, Howard, has $10 million in assets, which he intends to leave to his own children. Howard passes away shortly after they are married, and his $5.43 million exclusion is completely consumed by that $10 million. Because Howard – not Arnold – is now Betty’s “last deceased spouse,” her DSUE is zero. As such, the amount of Betty’s assets that can be shielded from estate taxes has been reduced from $7.68 million to her own $5.43 million exclusion. If Betty dies in 2015, the federal estate tax obligation would be $900,000 more than if she had never married Howard (40% of the $2.25 million exclusion she “inherited” from Arnold but lost when Howard passed away).
This example illustrates the importance of periodically reviewing your estate plan with your financial advisor. As you life’s circumstances change, adjustments in your estate planning may be necessary. Solutions are available to Betty, but the time to act is now. And that’s the subject of my next post.