Over the last several decades it has become routine practice to provide in a married couple’s estate plan for the division of the estate of the first spouse to die into two portions which are then to be held in two separate trusts. One portion is the amount that is exempt from federal estate tax (the “exclusion amount”) and the other is the excess, if any, for which the marital deduction is claimed. The result is no estate tax on the death of the first spouse, regardless of the size of the estate. Furthermore, because the exclusion amount is kept separate from the survivor’s estate it is not taxed when the survivor dies.
Two changes to the estate tax law contained in the recently enacted Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the 2010 Tax Relief Act) may appear to make that planning unnecessary.
The first change is the increase of the exclusion amount to $5,000,000 per person. Estates of couples which are expected to never reach the combined total of $5,000,000 during their lives theoretically no longer require establishing a trust for the exclusion amount for estate tax purposes. The second change can lead to the same conclusion for estates expected to remain under $10,000,000. One of the reasons for the division was the desire to “preserve” the exclusion amount of the first to die by keeping that part of the estate separate from the part that would be included in the estate of the survivor. Under Section 303 of the Tax Relief Act of 2010, the unused portion of the exclusion amount of the first to die can be claimed by the estate of the surviving spouse in addition to that spouse’s own exclusion amount. Therefore, even if the combined estate is included in the gross estate of the survivor there would be no estate tax if at that time the value is $10,000,000 or less.
Based on these changes it would be easy to conclude that there is no longer a need to keep any part of the estate of the first to die separate from that of the survivor. However, there are at least three reasons for reconsidering that tentative conclusion. First, Congress has proven to be very unpredictable when it comes to estate taxes (among other things). The changes that were made last year could be changed again (in a negative way). Remember that the estate tax was completely repealed at the turn of the century and has now returned.
Second, if the estate of the first to die foreseeably could grow to more than the exclusion amount before the survivor dies, use of the exclusion amount of the first to die at the time of death could save estate taxes compared with waiting to use it when the survivor dies. This is because the value of the assets could grow, but the exclusion amount of the first to die doesn’t! If appreciating assets equal to the exclusion amount are held in a separate trust as is currently common practice, the entire trust value, including growth, is excluded from the estate of the survivor!
Third, there is an important non-tax reason for maintaining separation of the estate of the first to die, rather than leaving it to the total control of the surviving spouse. If the estate of the first to die is left outright to the survivor, that survivor can do with it as he or she chooses, including deciding who should get it on his or her death. When the unlimited marital deduction became law many years ago there was reluctance to use it because at that time the surviving spouse had to be given full power over disposition. Recognizing this, Congress later eliminated the requirement of control over disposition, and the unlimited marital deduction became a standard feature of most estate plans.
Therefore, even though estate tax planning may no longer be an absolute reason for separation/segregation of the estate of the first to die, a couple should carefully consider both the tax and the non-tax implications before modifying an estate plan to simply leave everything to the survivor.
This brief overview of some important considerations associated with estate planning and taxation is by no means comprehensive. Always seek the advice of a competent attorney when making important estate planning decisions.