Portability of unused estate and gift tax exclusion between spouses.

• Author: Nuckolls, John M.

One of the essential elements in the equation for the computation of both the federal gift and estate tax is the reduction of the tax due by the amount of the estate or gift tax on the applicable exclusion amount (also known as the unified credit). For a married couple, because of the unlimited marital deduction available for property passing between U.S. citizen spouses, a significant amount of estate planning revolves around not wasting the applicable exclusion amount of the first spouse to die. Generally, this planning involves establishing and funding an irrevocable trust upon the death of the first spouse so as to fully utilize the applicable exclusion amount of the first spouse to die.

Because of changes to the tax law under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2011, P.L. 111-312, a surviving spouse, assuming an election is made by the executor of the deceased spouse's estate, will be able to increase his or her applicable exclusion amount by the amount of the unused exclusion amount of the deceased spouse (dying after 2010). This new ability to increase the surviving spouse's applicable exclusion amount by the unused exclusion amount of the deceased spouse has been described by estate planners as the "portability of unused exclusion between spouses."

The act accomplishes this change by redefining the term "applicable exclusion amount" to include the sum of the basic exclusion amount and the deceased spousal unused exclusion amount. The basic exclusion amount is defined to be $5 million and may be adjusted for inflation in the case of any decedent dying in a calendar year after 2011. The deceased spousal unused exclusion amount means the lesser of:

* The basic exclusion amount; or

* The excess of the basic exclusion amount of the last deceased spouse of the surviving spouse over the amount with respect to which the tentative tax is determined under Sec. 2001(b)(1) on the estate of the deceased spouse (in other words, the unused basic exclusion amount of the last deceased spouse).

The application of these new rules is probably best explained through examples.

Example 1--No prior taxable gifts and 100% marital deduction: Husband 1 (H1) dies in 2011 with a gross estate of $5 million and leaves the entire estate to Wife 1 (W1). W1 is a U.S. citizen. Because H1's estate passed entirely to his spouse, the unlimited marital deduction will reduce his taxable estate to zero, resulting in no use of the applicable exclusion amount. See Exhibit 1.

Exhibit 1: No prior taxable gifts and 100% marital deduction (from Example 1) Gross estate $5,000,000 Marital deduction 5,000,000 Taxable estate 0 Tentative tax 0 W1 now has an applicable exclusion amount equal to $10 million computed as follows: Sum of: Basic exclusion amount (of W1) $5,000,000 Plus: Deceased spousal unused exclusion amount Lesser of: Basic exclusion amount $5,000,000 or Basic exclusion amount...