In the past several years, federal estate tax exemptions, as low as $1.5 million as recently as 2005, have ballooned to the current level of $5.43 million (indexed for inflation). What this number means is that anyone dying with an estate valued under $5.43 million doesn’t owe any federal estate tax. As if this enormous exemption wasn’t enough, the concept of portability has recently been made a “permanent” feature of the tax law as well (insomuch as any law is permanent these days). Portability allows the first spouse to die to leave his unused exemption amount to the surviving spouse. Since spouses inherit free of estate tax in the first place, portability creates an effective federal estate tax exemption of $10.86 million for married couples (the first to die leaves everything tax free to the survivor, including his unused exemption, which she can then use in concert with her own exemption at death).
This extreme lenience has created an environment where the vast majority of people will never have to worry about paying estate taxes. Currently, only 0.2 percent of Americans pay estate tax in any given year. Many advisors look at these figures and decide that they can save their clients’ families a few bucks by simply not filing an estate tax return on the client’s death. After all, if they’re way below the exemption threshold anyway, why bother paying a fee for a filing that isn’t mandatory since it doesn't actually reflect any taxes owed? This line of thinking would be relatively sound, if advisors only had to worry about the first spouse to die. However, there’s still the issue of the surviving spouse; and that’s where portability comes back into the picture. In order to pass on the deceased spouses $5.43 million exemption, the executor must elect to do so on a “complete and properly filed estate tax return.”
Now, at this point, an advisor might ask, “Who cares about passing on the exemption if the client won’t have to pay the estate tax anyway?” Well, what happens if that surviving spouse comes into a great deal of money? Maybe her advisor (aka you) did a great job and grew her assets tenfold, or perhaps she took control of an existing family business and succeeded far beyond what her deceased spouse was capable of. Maybe she just hit the lottery. Regardless of the circumstance, if the surviving spouse’s potential estate grows beyond her individual exemption amount, her estate could be on the hook for an unexpected tax bill. And, something tells me that when the heirs come by your office to ask why they weren’t able to take advantage of the first spouse to die’s unused exemption, which can potentially protect millions, they won’t be assuaged by the few hundred dollars you saved by not filing an estate tax return.
Even if the odds of this scenario coming to pass seem long, the repercussions of not being prepared can be huge, and the costs to insulate your clients against this risk are minimal. Advisors should consider encouraging their deceased clients’ executors to file estate tax returns, regardless of the exemption level. Just think of it as “success insurance.”