Home News A Cautionary Tale: Deceased Spouse Estate Tax Exemption

By Alan Rudzewicz

What is DSUE?

A few years ago, Congress made a deceased spouse’s unused estate tax exemption portable. This provision applies to same sex married couples under Federal Law. At first glance, the tax exemption sounds like a good thing. However, spouses that have lost their significant other should develop their estate plans with caution.

Attorney Alan Rudzewicz
Attorney Alan Rudzewicz

DSUE or the Deceased Spousal Unused Exclusion, is based on the idea is that a married couple should be able to pass any unused exemption on to the surviving spouse in order to shelter the surviving spouse’s estate from federal estate tax. As of 2016, each person has a $5.45 Million estate tax exemption. This means the DSUE is potentially $5.45 Million and a married couple can shelter $10.9 Million of assets from estate tax with proper planning.

The requirements for DSUE are:

  1. married at time of death,
  2. death occurs after December 31, 2010,
  3. the transfer of DSUE is made to a surviving spouse,
  4. the election to transfer the DSUE is made on a timely filed estate tax return (Form 706), and
  5. the DSUE of the last deceased spouse eliminates any DSUE previously transferred to the surviving deceased spouse.

The fifth requirement may result in a tax trap for people that remarry. See the example below.

Why should someone be concerned?

The increased amount of the current estate tax exemption creates different issues for advisors and planners as well as their clients. There are many existing estate plans that more than likely need review. Future estate plans also need to include a response to this change in the estate and gift tax law.

The high threshold for the exemption has resulted in some people thinking that estate planning is not necessary or that they have nothing to worry about because they will never achieve an estate in excess of $5.45 Million. However, we have not figured out how not to die, how not to argue about money, how not to have dependency or addiction issues, how not to make transferring a family business a source of consternation, how not to have family squabbles about Aunt Minnie’s tea cozy and doilies that were crocheted by Aunt Minnie and are priceless. Well, you get the point. The need for proper planning still exists and the need for insurance still exists, even in those situations where a person may have considerably less than $5.45 Million.

What are the financial planning options?

1.    Existing Estate Plans

For single clients, the planning does not really change, the exemption increases, which is a good thing!

For those married clients with joint trusts, the new exemption amounts do not pose much of a problem. It is business as usual. Their exemption rate went up and a bonus is that an unused exemption for the first spouse that dies can carry-over to the survivor.

For those married clients with the separate A-B trusts a/k/a Credit Shelter Trusts or what we might call the traditional revocable living trust, there are some planning items to consider. One option is to “salvage” the old plan that may have cost a pretty penny by amending the tax language in the trust. You can accomplish this in a couple of ways:
– eliminating it entirely and giving everything to the surviving spouse;
– putting a cap on the exemption amount, say $2 or $3 Million and leaving the rest to the surviving spouse; or
– leaving the credit shelter fully funded and the entire $5.45 Million goes into the Family Trust.

A second option is to re-draft the plan and consider the use of a joint trust for the married couple in place of the old separate trusts. One thing to consider with this option is the titling of assets. If the separate trusts are funded with accounts and other property, it may be a pain to move these accounts around (one reason to consider adjusting the tax clause in the old trusts).

2. Future Estate Plans

Single people – again, not much change. Married couples will look to joint trusts as a first alternative in many cases. However, family situations that involve blended families, second marriages and large amounts of assets may be a good reason for financial planners to recommend the use of separate trusts instead of joint trusts for married couples.

Example of what can happen

An example of the trap mentioned in our opening section is as follows: Assume, for purposes of rounding off the numbers, that the exemption from federal estate tax is $5.5 Million per individual or $11 Million total for a married couple.

Joe and Jim, a married couple, have $11 Million in assets and decide to skip any estate tax planning trusts because the unused exemption of the first spouse to die can be transferred to the survivor. Joe dies, leaving his $5.5 Million estate to Jim outright. Jim files a 706 Estate Tax Return as the rules require. Jim now owns a total of $11 Million in assets and assumes that he is covered for estate tax purposes.

Jim then meets a nice guy, Steve and remarries. Steve, who is also widowed, has three adult children from his first marriage. Jim has no children, but has close family. He and Steve are both well off and agree to leave their respective estates to their respective beneficiaries. Then, Steve dies with an estate valued at $5.5 Million, leaving it all to his children.

Jim dies a year later after Steve his second spouse and without the benefit of Joe’s DSUE because his last spouse to die was Steve. Steve did not have any DSUE left because Steve gave his entire estate to his children, thereby using up his entire exemption. Joe’s DSUE was wiped out by Steve’s death since Steve was the last deceased spouse of Jim. Assuming an approximate estate tax rate of 40%, Jim’s estate now has to pay over $2 Million in estate tax. Under a special rule for multiple spouses, if Jim had made taxable gifts during his lifetime and prior to Steve’s death, (or if Jim died before Steve) he would have been able to use Joe’s DSUE and save quite a bit of tax.

It is important to note the various family dynamics that may affect the planning. The increased exemption should be prompt any financial advisor or client to revisit their estate planning.

Attorney Alan Rudzewicz specializes in the administration and planning of estates so that family assets and the future family legacy are protected. His practice concentrates on estate planning, estate tax, probate and trust administration, corporate law, business planning and real estate.