Portability… How Valuable Is It?
Each United States resident is subject to the federal estate and gift tax and is entitled to a $5.450 million applicable exclusion amount (“AEA”) (often called the Unified Tax Credit or the basic exclusion amount) which reduces their federal gift and estate tax. Technically, the $5.450 million does not directly reduce the federal estate or gift tax but is equivalent to an approximately $2 million credit against such tax ). Thus, if an individual’s federal taxable estate is under their remaining AEA, then no federal estate tax is incurred. If an individual is married and does not use all of their AEA to avoid estate taxes, then a United States citizen surviving spouse can use the decedent’s unused AEA via “portability” (there are rules for non -itizen spouses but this blog does not address those issues). I have discussed portability in a prior blog.
Suppose Sue and Harry are married and jointly own $5 million of assets. Upon Sue’s death, for federal estate tax purposes, the value of her estate is $2.5 million (50% of $5 million) but, because the assets are distributed to her spouse, a US citizen, a full marital deduction is allowed and no federal estate tax will be due. If Harry wants to use Sue’s remaining AEA (100% of the $5.450 million as Sue had not used any of the AEA during her lifetime), then Harry must file a federal estate tax return for Sue whereby he would elect portability. Then, if Harry dies without having remarried and without using any of his own AEA, he will have not only his AEA at the time of his death (in 2016, $5.450 million) but ALSO Sue’s$ 5.450 million or a total of $10.900 million! Sue’s additional AEA of $5.450 million at a 40% rate is another potential tax savings of $2,180,000!!! If Sue and Harry are in their second marriage, then Harry’s beneficiaries would receive the benefit of such federal estate tax savings.
A recent case illustrates what happens if this portability decision is not carefully considered and how a beneficiary of the surviving spouse’s estate can benefit from these decisions.
In Walton v. Estate of Glenn Swisher, an Indiana court determined that someone may not enjoy the benefits of a contract with out also accepting its burdens. In Swisher, Kathleen as personal representative of her mother’s, Mary Cox Swisher (“Mary”), estate claimed that her stepfather, Glenn’s estate was unjustly enriched at the expense of Mary’s estate.
Mary died on Mary 14, 2011 and Kathleen was appointed personal representative . On September 8, 2011, she signed a Letter of Understanding (the “Letter”) with Glenn, Mary’s surviving husband. The Letter required Glenn to pay certain financial obligations and Mary’s estate agreed to “relinquish any and all claims to any tax benefits or refunds received after date of death on any tax returns filed by Glenn…” .
Even though Mary’s estate was only approximately $100,000, Glenn filed the federal estate tax return for Mary and elected portability. Kathleen, as Mary’s personal representative, signed the federal estate tax return filed on February 9, 2012 and ultimately Mary’s estate was closed.
On July 20, 2012, Glenn died and notice to creditors was sent on August 17, 2012. On November 14 Kathleen filed a claim against Glenn’s estate for $500,000 for compensation for the use of Mary’s AEA.
The court found that the Letter was NOT ambiguous and Kathleen’s claim was denied. Kathleen appealed to the Indiana Court of Appeals which affirmed the lower court, noting that the “Letter clearly outlines the benefits due to and burdens placed on Mary’s Estate and Glenn respectively.” Further, Kathleen was represented by counsel. She argued that Glenn’s representative (not her attorney) had a duty to explain to her portability and the AEA. The appellate court disagreed with Kathleen and affirmed the lower court decision.
ADVICE: IF the attorney did not advise Kathleen, then obviously the attorney failed in his duties to his client. However, her attorney could have clearly advised Katherine and she ignored his advice. Discussion and decisions on portability MUST be documented. If, for any reason, a surviving spouse decides not to elect portability or the portability issue is involved in negotiations such as a prenuptial agreement, an advisor should document these discussions and decisions. The complainants, who will be the beneficiaries, will be questioning the decisions, especially if the tax savings are large enough (and even if the tax savings are small!). ANY time federal tax benefits are being negotiated or reviewed, obtain qualified tax counsel.
WORD OF THE WEEK: Ambiguous… A contract is ambiguous only where a reasonable person could find its terms susceptible to more that one interpretation. In legal cases, if there is ambiguity, then certain evidence can be admitted; whereas, if the contract is not ambiguous, then the review is limited to the “four corners” of the document.
GENEROSITY IS A KEY TO HAPPINESS …REACH OUT AND HELP SOMEONE TODAY! 😎