The applicable exclusion amount is the amount that can be sheltered from federal gift and estate tax by the unified credit. The applicable exclusion amount (the basic exclusion amount in 2011 and 2012, see more below) is $5 million in 2011 and 2012 (the $5 million amount will be indexed for inflation in 2012), but is scheduled to drop to $1 million in 2013. In 2011 and 2012, the unused basic exclusion amount of a deceased spouse is portable which may make it easier for you and your spouse to take full advantage of the estate tax applicable exclusion amount.

You have some flexibility over when to use some or all of your applicable exclusion amount. You could use your applicable exclusion amount to make a gift now. Your estate could use your applicable exclusion amount at your death. Or, if you are married, your estate could elect to not use your applicable exclusion amount, instead transferring it to your spouse for later use. There are potential advantages and disadvantages to using your applicable exclusion now rather than later.


Tip: The top gift and estate tax rate is 35 percent in 2011 and 2012, but is scheduled to increase to 55 percent in 2013.


Caution: Unless the current rules are extended by Congress, starting in 2013, the gift and estate tax rates increase, the applicable exclusion amount decreases, and portability of the unused basic exclusion amount between spouses expires.


Technical Note: In 2011 and 2012, the applicable exclusion amount of the surviving spouse is equal to the sum of the basic exclusion amount of the surviving spouse and the unused basic exclusion amount of the last deceased spouse. The Internal Revenue Code refers to the unused basic exclusion amount of a deceased spouse as the deceased spousal unused exclusion amount (DSUEA).


Potential upside

Since any unused exclusion amount can be passed along to a surviving spouse, you might assume that there is an advantage in doing so. But that’s not necessarily the case. Even with the current portability of the basic exclusion amount, there could be an upside to using some or all of your applicable exclusion amount now, by making lifetime gifts, or by implementing a plan that will allow your estate to utilize your applicable exclusion amount, rather than electing to transfer it to your surviving spouse. This can be the case if:

  • There are family members or individuals other than your spouse that you would like to benefit during your lifetime. The applicable exclusion amount could be used to shelter gifts to such persons from gift tax.


Tip: Consider also lifetime gifts that qualify for the annual gift tax exclusion, currently $13,000 per donor/donee, or as qualified transfers for medical or educational purposes. These gifts are not taxable and do not use up your applicable exclusion amount.

  • There are family members or individuals other than your spouse that you would like to benefit after your death, but prior to the death of your spouse. At your death, you will generally need to shelter transfers to persons other than your spouse from estate tax using the applicable exclusion amount.
  • There are concerns about whether the exclusion will continue to be portable between spouses in the future. If the exclusion is used now, the exclusion will have been used even if portability is not available in future years. If the exclusion is not used now and portability is not available in the future, the unused exclusion of the first spouse to die could be lost.

Example(s): Don and Lisa are married and Don has an estate of $6 million. Assume an applicable exclusion amount of $5 million, a 35 percent top tax rate, portability, and that current exclusion amounts are extended beyond 2012 and remain constant. Don dies first. Don transfers $6 million to Lisa. The transfer qualifies for the marital deduction and no federal estate tax is due at Don’s death. Don’s estate elects to transfer Don’s unused exclusion to Lisa.

At Lisa’s death some years later, assume portability is not available. Lisa’s $6 million estate is greater than her $5 million applicable exclusion amount and estate tax is due. If Don instead had transferred $1 million to a credit shelter trust for Lisa and their children, Don’s $1 million estate would have been fully sheltered by his $5 million applicable exclusion amount and Lisa’s $5 million estate would have been fully sheltered by her $5 million applicable exclusion amount, and no federal estate tax would be due at either death.

  • There are concerns that the applicable (or basic) exclusion amount will be lower in the future. If the higher exclusion is used now, you will have taken advantage of the higher exclusion. If the higher exclusion is not used now and the exclusion is reduced in later years, the total amount sheltered by both spouses’ exclusions could be reduced.

Example(s): Rick and Tina are married and Rick has an estate of $8.5 million. Rick dies first. At Rick’s death, assume an applicable exclusion amount of $5 million, a 35 percent top tax rate, portability, and that values stay constant. Rick leaves everything to Tina, everything qualifies for the marital deduction, and no federal estate tax is owed. Rick’s estate elects to transfer Rick’s unused exclusion to Tina.

At Tina’s death, assume an applicable exclusion amount of $3.5 million, a 35 percent top tax rate, and portability (i.e., assume future provisions include a combination of 2009 and 2011 tax provisions). At Tina’s death, the $8.5 million is greater than the $7 million applicable exclusion amount (Tina’s $3.5 million basic exclusion amount and Rick’s $3.5 million unused exclusion amount) and estate tax is due. Part of Rick’s basic exclusion amount, $1.5 million, is wasted. If Rick instead had transferred $5 million (or even $1.5 million) to their children or to a credit shelter trust for Tina and their children, both estates would be fully sheltered by their applicable exclusion amounts and no federal estate tax would be due at either death.

  • There are concerns that federal gift and estate tax rates may be higher in the future. Transferring property now that will not be taxed later can insure that the transferred property will not be subject to those higher tax rates in the future.
  • You have property that is expected to appreciate after you make a gift. Future appreciation on the property will escape gift and estate taxation and does not use up any additional applicable exclusion amount.


Tip: Consider a grantor retained annuity trust (GRAT) to transfer appreciation while using little or no applicable exclusion amount (where the GRAT is zeroed out). This is complex planning, so see a qualified estate planning attorney for more information.

  • You have property that is expected to appreciate in value after your death. Future appreciation of the property will escape estate taxation in your spouse’s estate and does not use up any additional applicable exclusion amount. If the property instead passed to the surviving spouse, it could potentially outgrow any unused exclusion transferred to your surviving spouse; any unused exclusion is not indexed for inflation.

Example(s): Dave and Ann are married and Ann has an estate of $10 million. Assume that current rules are extended beyond 2012 with an applicable exclusion amount of $5 million (that is indexed for inflation after the first spouse dies), a 35 percent top tax rate, portability, and that values (other than any unused exclusion) double over time after the first spouse dies. Dave dies first. Dave’s estate elects to transfer Dave’s unused exclusion to Ann. At Ann’s death, Ann’s $20 million estate is greater than her $15 million applicable exclusion amount (Ann’s $10 million exclusion amount and Dave’s $5 million unused exclusion), and estate tax of $1,750,000 is due. If Ann instead had transferred $5 million to Dave prior to his death, Dave’s $5 million estate would have been fully sheltered by his $5 million applicable exclusion amount (assuming Dave transfers the $5 million to a credit shelter trust or to beneficiaries other than Ann) and Ann’s $10 million estate would have been fully sheltered by her $10 million applicable exclusion amount, and no federal estate tax would be due at either death.

  • You and your spouse would like to benefit multiple generations and use both of your generation-skipping transfer tax (GSTT) exemptions. The GSTT exemption, unlike the basic exclusion amount in 2011 and 2012, is not portable. The GSTT exemption is the same as the applicable exclusion amount in 2011 and 2012, $5 million (plus indexing in 2012), but is scheduled to drop to $1 million as indexed in 2013. The GSTT rate is the same as the top gift and estate tax rate, 35 percent in 2011 and 2012, but is scheduled to increase to 55 percent in 2013. Applicable exclusion amounts will often be used with generation-skipping transfers to protect the transfers from gift and estate tax.


Tip: A reverse QTIP election could be used with a QTIP (qualified terminal interest property) marital trust to allow both spouses to allocate GSTT exemption to property that passes to the surviving spouse using the marital deduction. This is complex planning, so see an experienced estate planning attorney for more information.

  • State death taxes can be saved. Most states do not have a gift tax. Making a gift can remove the property from your estate for state death tax purposes. Also, state exclusion amounts may be different than the federal applicable exclusion amount and may not be portable between spouses. Using some federal applicable exclusion amount at the first spouse’s death may insure that the state exclusion (which may not be portable) is also used at the first spouse’s death. Consult with a financial or estate planning professional familiar with laws in your state of domicile.


Potential downside

There may be a downside to using the applicable exclusion amount (or a portion of it) now, by making lifetime gifts, or by implementing a plan that will allow your estate to utilize your applicable exclusion amount, rather than electing to transfer it to your surviving spouse. This can be the case if:

  • You make a lifetime gift of property, with the result that the property is no longer available as a resource to you.
  • Property that bypasses your surviving spouse’s estate does not receive a step-up (or step-down) in basis at your surviving spouse’s death. This could result in greater income tax, for example, when property is sold. Property included in your surviving spouse’s gross estate for estate tax purposes generally receives a step-up (or step-down) in basis to fair market value. Your plans should attempt to balance estate tax and income tax considerations.
  • Using the applicable exclusion amount by transferring property to an individual other than your spouse means that your spouse will not receive that property at your death. Many estate plans that were designed prior to the recent substantial increases in the applicable (or basic) exclusion amount and before portability funded a credit shelter trust with an amount equal to the applicable exclusion amount, with the balance going to the spouse or a marital trust for the spouse. Under today’s rules, such a plan could end up leaving everything to the credit shelter trust and nothing to the spouse (other than whatever interests the spouse might have in the marital trust). To avoid this situation, smaller estates may prefer to leave everything (or an amount expected to be no more than the surviving spouse’s applicable exclusion amount) to the surviving spouse (or to a marital trust for the surviving spouse).

Example(s): You have an estate of up to $5 million and an A/B trust arrangement that would fund your “B” credit shelter trust with the applicable exclusion amount (with the balance passing to your spouse or an “A” marital trust for your spouse). Assume an applicable exclusion amount of $5 million. Your B trust would be funded with the full amount of your estate, with nothing passing to your spouse (other than whatever interests your spouse might have in the B trust). Is this the result you would want? What if your estate or the applicable exclusion amount were larger or smaller? Does portability of the basic exclusion amount between spouses affect your decision?


Tip: Your documents and plans may need to be revised to reflect the tax changes for 2011 and 2012 and for the uncertainty in 2013 and beyond. Flexibility to deal with future changes is key. Everyone’s situation is unique and the issues are complex. To help guide you through these opportunities and uncertain times, consult with an experienced estate planning attorney.

  • State death taxes would increase at the death of the first spouse to die. State exclusion amounts may be less than the federal applicable exclusion amount. This could cause state taxation at the death of the first spouse to die if the full federal applicable exclusion amount is used. Consult with a financial or estate planning professional familiar with your state’s laws.
  • Cumulative events lead to an increase in the estate tax owed in the future. Because of the complexity and cumulative nature of the gift and estate tax calculations (including possible changes to tax provisions), gift or estate tax may be higher than you might ordinarily expect in some cases. Tax benefits already taken, such as the applicable exclusion amount, could potentially be clawed back by future changes, such as a reduction in the applicable exclusion amount. Where there may be potential clawbacks, it may be especially useful to compare using the applicable exclusion amount now against deferring its use. Consult with a financial or estate planning professional.

Example(s): Nancy is married to Don. Assume an applicable exclusion amount of $5 million, a 35 percent top tax rate, and portability. Don dies and transfers $1 million of Don’s unused basic exclusion amount to Nancy. Nancy makes a gift of $6 million using Nancy’s $6 million applicable exclusion amount (Nancy’s $5 million basic exclusion amount plus Don’s $1 million unused basic exclusion amount) and no federal gift tax is owed. Nancy marries Mark. Mark dies and fully uses up Mark’s basic exclusion amount. Nancy dies with an estate of $1 million and $700,000 of federal estate tax is owed. (Tax would only be $350,000 if the $1 million were simply taxed at 35 percent. But the estate tax calculation reflects that Nancy has previously made taxable gifts of $6 million on which there is no gift tax.) However, the results are no worse than if Nancy had made no taxable gifts and her estate were $7 million at her death: estate tax would be $700,000.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2011.

Investment Advisor Representative: Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor.  Registered Representative: Securities offered through Cambridge Investment Research Inc., a Broker/Dealer, Member FINRA/SIPC.  Cambridge and Affinity Wealth Advisors Inc are not affiliated.