Couples with estate planning needs only have a small window of opportunity to make changes or adjustments to their estate plans before federal estate tax exemption levels change and tax hikes set in on January 1, 2013.

For 2012, the current law provides a generous $5,120,000 per person federal estate tax exemption and taxes estates over that amount at a top rate of 35%. This compares with a $1 million per person federal estate tax exemption and a 55% effective top tax rate scheduled to go into effect on January 1, 2013.

Perhaps even more important for some married couples, the current law contains a portability provision. During 2012, if one spouse dies without using up his or her federal estate tax exemption, the unused portion may be transferred to the surviving spouse if elected by the executor of the estate of the first-to-die spouse.

Jennifer Ridgely advises “This provision provides a way for couples whose estates are below a certain dollar amount to take advantage of each other’s exemption, without having to create complicated trusts or wills.”

The portability provision may benefit certain couples. Just keep in mind that the current law will expire at the end of 2012, and, if Congress does not act, the federal estate tax exemption will revert to $1 million with an effective 55% top rate and no portability option. So, you’ll want to work closely with your estate and tax advisers to discuss your plan and potentially update it to reflect any changes to the law.

There are many considerations and limitations associated with planning for portability that could impact your overall estate plan, especially because this provision is set to expire at the end of 2012. The details may or may not lead you to revise your existing plan. Here are some of the details you should consider when you consult a tax or estate planning professional.

Portability applies to the surviving spouse. Unused federal estate tax exemptions cannot be transferred to anyone but a surviving spouse. Please note: If one spouse dies before 2013, having transferred any unused portion of the federal estate tax exemption to a surviving spouse, and the surviving spouse lives past 2012, assuming the sunset provision goes into effect, the transferred exemption will be lost.

States have their own estate taxes. Approximately 22 states, plus the District of Columbia, impose an estate and/or inheritance tax. These state estate taxes are separate from the federal estate tax, and most have exemptions that are lower than the current $5,120,000 federal estate tax exemption. You may want to ask your adviser about traditional estate planning options that may help minimize the potential impact of state estate and/or inheritance taxes.
What happens when assets appreciate?

With traditional estate planning, the amount exempted from federal estate taxes for the first-to-die spouse is put into a trust for the benefit of the surviving spouse. The assets in this trust, no matter their amount, are outside of the surviving spouse’s estate for estate tax purposes. This means that this trust can appreciate in value to any size, and will not be subject to federal estate taxes when the surviving spouse dies.

With portability, however, when one spouse dies and transfers assets and any unused portion of the federal estate tax exemption to the surviving spouse, any appreciation on the deceased spouse’s assets will be included in the estate of the surviving spouse. If the surviving spouse’s estate (including the deceased spouse’s assets and appreciation on those assets) is larger than the surviving spouse’s available federal estate tax exclusions (including any unused federal estate tax exemption transferred from the deceased spouse), federal estate tax will be owed on the difference.

If you believe your total marital assets are above, or have the potential of appreciating above, the federal exemption amount, you may want to consider working with an estate planning professional to create a traditional estate plan. By doing so, you can help ensure that appreciation of the first-to-die spouse’s assets accumulates outside the surviving spouse’s estate.

Additional Planning Point: Portability is set to expire at the end of 2012. If one spouse dies before the end of 2012 and transfers any unused portion of the federal estate tax exemption to a surviving spouse, and the surviving spouse lives past 2012, assuming the sunset provision goes into effect, the transferred exemption will be lost for the surviving spouse.

Portability does not apply to the generation-skipping transfer (GST) exclusion. In 2012, individuals can exclude up to $5,120,000 worth of transfers from the GST tax, versus $3.5 million in 2009. Unlike the federal estate tax exemption, however, the GST exclusion is not portable, as any unused portion does not transfer to a surviving spouse. You should consult your estate planning attorney to determine whether you should make a GST in the future. If so, ask how to effectively utilize all available GST exclusions.
Getting a plan in place

In light of the current law and pending changes set to take effect in 2013, you may want to revisit your estate plans with an adviser. Here are some potential next steps to consider.

Update your existing estate plan. If you have an existing estate plan in place, you may want to revisit your plan with your adviser in light of the current law, including its portability provisions, with an eye to the pending expirations in 2013. This task may involve drafting new wills and amending existing living trusts. If this is not done prior to your death, your surviving spouse may be limited by elements of your existing estate plan that fund certain trusts or distribute estate assets to other heirs, in light of applicable law, including portability.
Establish a plan if you don’t have one. To take advantage of current tax law, including the potential use of portability provisions, consider putting a properly written plan in place before your death. For example, your desire to transfer all of your assets to your surviving spouse and, at least for 2012, to take advantage of portability may be frustrated if you don’t hold all your assets jointly with your spouse and you don’t have a will in place to transfer your assets to your surviving spouse. Otherwise, your state’s intestacy laws may control the distribution of your estate and, as a result, all of your assets may not transfer to your surviving spouse.
Update your beneficiaries and joint ownership. As always, be sure to update the beneficiary designations on any retirement accounts, transfer on death (TOD) accounts, annuities, life insurance policies, and any other financial instruments that have named beneficiaries, to ensure that these accounts are included in your estate plan. Naming your spouse as joint owner or beneficiary of your accounts can potentially provide a simple way to avoid state intestacy laws and, at least for 2012, take advantage of portability.

Contact Us: If you need help preparing for multiple contingencies and any potential changes Congress may enact, or might benefit from Family Office Services, please contact Jennifer Lynch Ridgely, Principal in Charge of Daszkal Bolton Family Office, at jridgely@dbllp.com.