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Do-it-Yourself Estate Tax Pitfall

Dealing with the Internal Revenue Service (IRS) often confuses people and leads to complications. That holds true even in situations where the IRS has tried to simplify a process. Take, for example, the estate tax. As a new Wall Street Journal story this week mentions, new rules seeking to make it easier for couples to share assets and still receive the maximum estate tax exemption may lead to problems if families are not careful.

The Issue
In June the IRS offered guidance on federal estate tax laws. Under current law–set to expire at the end of this year–each individual can exempt $5.12 million of property from the tax. When taken together, a couple can therefore shelter over $10 million from these taxes. Yet, there were always complications when one spouse sought to leave everything to the other spouse, because this act essentially eliminated one half of the exemption. Transfers between spouses were not taxed, but upon the death of the second spouse the entire amount would be taxed with only the individual spouse’s exemption rate applying.

In the past, estate planning attorneys were able to work with families to craft trusts to get around this issue. However, in an effort to simplify the situation, the IRS made each exemption “portable.” That simply means that a surviving spouse can take advantage of a deceased spouse’s unused exemption.

The Concern

There is a mistaken assumption that these new IRS rules will apply automatically and that surviving spouses need not do anything to take advantage of the rules. That is not true. Instead, an estate tax return must be filed after the first partner’s passing–often within nine months of the death. Failure to complete this paperwork properly may result in losing the second exemption.

For this reason, it is absolutely crucial for families to have guidance from those familiar with these estate tax issues. Hundreds of thousands or even millions of dollars may be lost.

It is important to note that it is not only those with millions in a bank account which may be affected by these taxes and portability issues. In fact, many have noted that those most at risk of falling victim to unfamiliarity with the new rules are those with assets tied up in small businesses or family farms. The value of property passed along may inch above the exemption rates for a single spouse, and many of these families may not be receiving professional advice on these matters.

The situation is complicated even further if several marriages are involved. For example, a widower may not be able to use the exemption from both a first and second wife–though the first wife’s exemption can be used so long as the second wife is still alive. The bottom line is that these estate tax issues can get complex very quickly–even after the “simplification” from the IRS.

As with all estate tax issues, some community members are holding off on their planning with the assumption that the rates and levels are likely to soon change. While the tax is certainly in flux, the “portability” option is likely to remain in place no matter what changes are made.

If you have questions about this issue in our area, reach out to a San Diego estate planning attorney to learn more.

See Our Related Blog Post:

Taking Advantage of Estate and Gift Tax Laws

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