In prior postings, I wrote about the Deceased Spouse’s Unused Exclusion (DSUE), and the unintended consequences of a reduced DSUE when a surviving spouse remarries.
In today’s post, I’ll be writing more about Betty and Howard. You’ll recall that Betty’s first husband, Arnold, passed away in 2013, leaving $3 million to the couple’s children. Although his estate was not large enough to require that an estate tax return be filed, an estate tax return was filed anyway and an election was made allowing Betty to “inherit” the unused portion of the estate tax exemption from Arnold’s estate. As such, Betty’s total 2015 estate exclusion amount is $7.68 million (her own $5.43 million exemption for 2015 plus the $2.25 million DSUE).
This is the point at which smart couples recognize their mortality and take actions to protect their heirs. If Howard dies, he will become Betty’s “last deceased spouse,” and Betty’s estate would be forced to use his $0 DSUE instead of the $2.25 million DSUE she “inherited” from her first husband, Arnold. Betty’s estate would be able to shield only $5.43 million from taxation, rather than $7.68 million available to her while Arnold is still her “last deceased spouse.”
Fortunately, the DSUE Betty acquired through Arnold’s estate can be used as an additional gift tax exclusion instead of waiting for her estate to use the exclusion after she dies. This provision allows Betty to act now and gift $2.25 million to her children, using the DSUE she “inherited” from Arnold to shield the gift from taxation. The DSUE is used before Betty’s own exclusion, which is $5.43 million for 2015 and will continue to grow with inflation for the remainder of Betty’s life. If Betty lives a long and healthy life, that exclusion will grow as time marches on since it is indexed for inflation. If Howard passes away first and has an available DSUE, Betty can again inherit Howard’s DSUE and it can be used to further shield her estate assets from taxation.
By using the DSUE she received from Arnold’s estate while it is still available to her, she can protect her children from $900,000 in estate taxes ($2.25 million exclusion she would lose if Howard predeceases her x 40% federal estate tax rate). In addition, these gifts grow in the hands of Betty’s children (assuming they are properly invested), allowing them to enjoy the benefits of growth without incurring a potentially-taxable transfer of appreciated assets. Perhaps most importantly, Betty is still around to watch her children enjoy her gift!
As I’ve noted previously, everyone’s situation is different, and the solution that worked for Betty may not be the best course of action for you. State community property laws, how assets are titled (tenants in common verses joint tenancy with right of survivorship), and other specific circumstances may recommend a different course of action. The important lesson, however, is that the time to make a plan is before the plan is needed; the time to consider the tax consequences of your estate plan is before the tax man comes knocking on the door of your heirs.