Portability of a Married Couple's Estate

On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, or TRUIRJCA, but I will call it the "tax compromise." The tax compromise impacted federal estate taxes in a number of ways. One of the more surprising changes was including "portability" of a married couple's federal estate tax exemption between the married couple. I say "surprising" because all the other changes to estate taxes were some version of current estate tax procedures while "portability" was brand new.

Portability for federal estate tax purposes means that a surviving spouse can take advantage of the unused exclusion amount of his or her predeceased spouse by adding the unused exclusion amount of the first to die spouse to the exclusion amount of the surviving spouse. For example, if Husband A dies using up only $2.5 million of their federal estate tax exemption, then Wife B has a $7.5 million exemption on the remaining assets - Wife B's $5.0 million exemption plus the remaining $2.5 million exemption from Husband A. This means a married couple can have $10 million in assets exempted from the federal estate tax.

There are a couple of caveats:

  1. A "timely and complete" estate tax return must be filed with an election with the IRS to "preserve" portability. That means the estate must file a Form 706 when the first spouse dies, even if there is no federal estate tax due (see more on this below). Even if the executor of the estate of the first spouse to die is not otherwise obligated to file a Form 706, it must be filed to preserve portability. For Form 706 to be complete, all of the assets owned by the decedent at his or her date of death must be properly valued and listed.
  2. Portability is valid until December 31, 2012. What will happen to the transferred portion of the unused exclusion if a first spouse passed away in 2011 or 2012 and the second spouse lives past January 1, 2013, is as clear as a puddle of mud. Some in the industry have argued that portability is only valid if both spouses pass away in the portability time period of 2011 or 2012. Others state that the law was intended to allow the second spouse to carry portability until the second spouse dies. I would guess the latter group has more older male clients with much younger wives.

On June 17th, the IRS finally issues temporary and proposed regulations for portability. Yes, it has been 18 months since portability was instituted. But, this type of uncertainty is just the way it is in the estate planning world right now. The IRS regulations gave some context to electing portability, including:

  • If the estate of the first spouse is below the exclusion amount, the deadline for electing portability is still the due date of the Form 706, i.e. 9 months from date of death of the first spouse.
  • If the estate is below the exclusion amount, an electing personal representative will not have to report the value of property subject to the martial and charitable deductions.
  • An electing personal representative must include a calculation of the decedent's deceased spousal unused exclusion ("DSUE") amount, i.e., the amount eligible for portability when filing Form 706.
  • Only the personal representative can make the election. So if the surviving spouse is not the personal representative, and the personal representative decides to not file Form 706 or make the election, the surviving spouse cannot overrule the personal representative.

Portability codified what many people already do in their estate planning by creating what are known as A/B trusts or "credit" shelter trusts to save on estate taxes. Portability also reduces the need for married couples to retitle assets to equalize their respective estates for the federal estate tax exemption levels purposes. But, if you live in a state with state estate taxes, like Maryland or DC, you will still need to create some form of credit shelter trust to diminish the impact of any state estate taxes.

Until the end of 2012, portability provides some protection to those that do not plan but it is not a substitute for proper estate planning or updating your plan for life changes or changes in the law.

Basics of Estate Planning: Joint Tenancy is Not a Good Estate Plan - Part II

Last Month, I listed a number of scenarios that demonstrated that the inflexibility of joint tenancy with the right of survivorship ("JTWROS") might result in the wrong person inheriting your assets. Part 2 will deal with the tax and familial transfer issues that arise when a person or a family uses JTWROS as the main tool to transfer assets.

The main reason people like JWTROS property is that it avoids probate and places the assets in the right person's hands. We can see from Part I that is not exactly true. But, there are other transfer concerns that arise even if the property does not fall into intestacy. Many couples as they age will add their children onto their deeds as JTWROS to avoid probate.

For example, Dad and Mom will add their two daughters (Daisy and Doreen) and son (Sam) to the deed as JTWROS to the home residence of Mom and Dad. The theory is that when Mom and Dad pass away, the property will pass to their children avoiding probate. Some people even assume that JTWROS will avoid estate taxes. That is incorrect. But, what happens if Daisy, Doreen and Sam all predecease Dad and Mom…that's right, the house will belong to the last person left alive - either Mom or Dad's estate.

What happens if there are grandchildren involved? Let's assume that Doreen has two children and has become divorced. Because of the current economic climate Doreen moved back into the home with her two children - Mom and Dad's grandchildren. Doreen also wants her inheritance to be passed onto her children. But, with JTWROS, that cannot happen. If Mom, Dad and Doreen all died in a car accident coming home from picking up the pizza, the house will be owned by Sam and Daisy. Doreen's two children will have no right in the house. Let's hope that Doreen had a good relationship with Sam and Daisy because they legal can evict Doreen's children from the home since the grandchildren have no ownership interest in the house.

The other issue with transferring JTWROS rights in the home residence is the tax implications that arise. For simplicity, let's tweak the above example and say Dad and Mom only have one child - Daisy. Dad and Mom bought the house back in 1987 for $100,000 in Great Falls, Virginia. The house has appreciated over the years to $1.6 million, even though, Mom and Dad never made any improvements in the house. Mom and Dad are growing older and decided to add Daisy to the deed as JTWROS.

We already have a tax issue.

Unlike the ability of married couples to gift assets to one another, Daisy is a child. Mom and Dad are limited by the gift tax rules in the amount they can give Daisy gift tax free. Mom and Dad can only give assets worth $13,000 to Daisy without consuming Mom and Dad's lifetime gift exemptions. Luckily, the current Lifetime exemption level is $5.12 million in 2012 and Mom and Dad can gift-split, i.e. the entire amount of the gift will be split between Mom's Lifetime gift exemption and Dad's. But, to get the exemption they need to file Form 709with the IRS when you file your 1040's every year. And, if you think the IRS is not looking out for people that fail to file. Think again

Mom and Dad have now passed away. I will assume that Mom and Dad did not have a taxable estate. Daisy has become the sole owner by JTWROS but has not lived in the house since she left for college 20 years ago. She now lives in Boston. She can do whatever she wants to the house. Daisy decides to sell the home because she has no intention of moving back to DC. She sells it for $1.6 million. Great deal!

She now has another tax concern. I thought this was going to be easier

Because Daisy was added to the deed as a JTWROS owner, she must go all the way back to the original purchase price of the house to set her original basis in the house. The original basis in the house will be used to calculate the long term capital gains, which is the difference from the original purchase price and the sales price. She now owes the IRS $225,000 in long term capital gains taxi . If she had inherited the house upon the death of her parents, she would have stepped up in basis to the value of the house at the date of death of her last surviving parent. If she does not sell the house until 2013, Daisy will also pay the 3.8% Medicare tax that will be imposed on unearned income in 2013 following the the Supreme Court's ruling on June 28th related to the Affordable Care Act.ii Depending on Daisy's financial situation that could potentially work out to an additional tax of $60,800.

The average person will say to me "my parent's house has not appreciated that much." But, here is another example, according to this chart; the nominal home price in Washington, DC in 1987 was $110,000 when Mom and Dad bought the house. In 2012, the nominal price is $310,000. If we hold all the rest of the above example the same, Daisy will pay $30,000 in capital gains. Depending on her other finances she could be pushed into a higher tax bracket. She could also owe the 3.8% Medicare tax on the unearned income depending on her financial situation and when she sells the house. Just a little estate planning could save a great deal of money.

Next month, I will get into additional reasons that using JTWROS estate planning is not ideal in the case of adding your child to your deed.

Estate of the Month: Not Your Average Joe

Many of my readers will find it somewhat ironic that the hardest article for me to write is the Estate of the Month. Some months it feels like no famous person has screwed up their estate to provide a teaching point. But, like clockwork, a famous person's estate will contain some issue to aid the Average Joe, or, in this case, the Average Joe Paterno

Joe Paterno was the longtime Penn State football coach who won more games than anyone in major college football but was fired amid a child sex abuse scandal caused by his former defensive coordinatoriii. The scandal, and his subsequent firing in November 2011, scarred his repuation for winning with integrity. Less than three months after being fired, Joe Paterno died on January 22, 2012, from lung cancer at the age of eight-five (85). However, it was the subsequent administration of his estate that is the estate planning teaching point.

On June 10th, reports started slipping out that Joe Paterno's Last Will and Testament, along with the administration of his estate would be sealed from public record. Joe Paterno's estate attorney filed Paterno's will on April 5th to open the administration of Paterno's estate and immediately petitioned the court to seal Paterno's records. One of five county judges - the docket did not even list the attorney ordering the file sealed - granted the petition and the public was denied access to view his will.

Paterno's will was the only last will and testament sealed in Centre County, where Paterno resided when he died, in the last 18 months. And, the last 889 decedents in Centre County were not as lucky to have their filed sealed.

Nothing in Paterno's estate warranted the special treatment. Are there many reasons why the Paterno family would like to preserve confidentiality? Sure, but, that would be true of most people, and the Paterno's are no different. His fame does not protect his estate from being reviewed by the general public. Even, Paterno's role as a grand jury witness in the prosecution of former defensive coordinator Jerry Sandusky on child sex-abuse charges would not warrant sealing his probate administration.

Not shocking, given Paterno's fame and tarnished image, several newspapers immediately filed motions with the court to unseal Paterno's will and probate administration. On June 15th, in a clear attempt to walk back from the controversy, the Paterno family stated their "request [for sealing] was entirely appropriate and totally consistent with the actions of other prominent individuals….The only objective was to preserve a measure of privacy for Sue Paterno, their five children, 17 grandchildren and other family members….In an effort to ensure maximum transparency and eliminate unfounded speculation, the family has decided to make the will publicly available." Sure.

You can read between the lines that the Paterno family believed they were afforded some level of special treatment for their father. But, just like everyone else, on JoePa's will and all the dirty laundry in the will is accessible to the public.

A review of the docket sheet of Joe Paterno's estate also revealed the following about his estate:

  • Paterno completed his last will and testament in June 1997 and updated his will with a codicil, in February 2010.
  • His widow, Sue, is the personal representative of his estate.
  • His estate paid a $200,000 inheritance tax on April 23.

How does this apply to the Average Joe? Well, you might not have rabid Penn State fans running to the court house to look at your will, but there might be discord in your family. Maybe you are disinheriting a child or giving more money to one family member than another. Maybe you are giving more money to charity than your loved ones. Maybe you understand that publicizing your will can open your estate and loved ones up to unwanted solicitations and advances by unscrupulous people. There could be any one of a hundred other reasons why you want to maintain your privacy from beyond the grave.

When you do not have a trust, and you use your will to disburse your assets, you ensure that the general public can view your will. Unlike Elizabeth Edwards, who held her assets in trust, JoePa is no different than Walter Cronkite, Whitney Houston, or John O'Quinn and anyone who only had a will controlling their probate assets. And with probate administration, anyone can see who, what and how much money is going where.

iHouse was purchased in 1987 for $100,000 and sold for $1.6 million. The long term capital gains is $1.5 million times the long term capital gains rate of 15%, calculates out to $225,000.

iiStarting in 2013, a 3.8% Medicare surtax on unearned income of high-income taxpayers will be levied on single filers with adjusted gross incomes (AGI) over $200,000 and joint filers over $250,000. The surtax is levied on the lesser of the filer's net investment income or the excess of AGI over the thresholds. Unearned income includes interest, royalties, dividends, capital gains, annuities and passive rental income, but not tax-free interest and retirement plan payouts.

iiiJerry Sandusky was the Defensive Coordinator for the Penn State Football team from 1977 to 1999. On June 22, 2012, Sandusky was found guilty on 45 of the 48 charges related to child-sex abuse.

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