Big Tax Change for Widows and Widowers Who Remarry

Widows and widowers who are considering remarriage should be aware that a law recently passed by Congress could make a huge difference in how much of their assets they are able to leave to their heirs after taxes.

In general, anyone who is considering remarriage later in life should talk to an estate planner first in order to avoid possible tax problems. But the new law gives added urgency to this advice.

Typically, when a person dies, his or her estate can give an unlimited amount to a surviving spouse tax-free. However, if the person’s bequests (plus large lifetime gifts) to other beneficiaries – such as children – total more than a certain “exemption amount,” then an estate tax must be paid. For 2013, the exemption amount is $5.25 million.

In the past, the general rule was that the exemption amount applied separately to each spouse. So if a husband died first, his estate could use his exemption amount, and when his wife died later, she would have her own exemption amount.

But under the new law, if the first spouse to die doesn’t use all of his or her exemption amount, the difference can be passed along to the other spouse. (This was true in 2011 and 2012 as well, but on a temporary basis. The new law makes this rule permanent.)

Suppose a husband dies and doesn’t use any of his $5.25 million amount (because he leaves everything to his wife). When the wife dies, her exemption amount will be her own $5.25 million plus the $5.25 million that the husband didn’t use. This means that instead of being able to leave $5.25 million tax-free to her heirs, she can leave $10.5 million tax-free – a potential savings of millions of dollars.

How does this affect remarriage? It has a big effect, because if a widow or widower marries a new spouse, and the new spouse dies first, the widow or widower will lose any “leftover” exemption from the first spouse, and will have only the exemption from the second spouse.

So suppose a widow “inherits” a $5.25 million exemption from her first spouse. If she remarries someone who has a $0 exemption, and he dies first, the widow will lose the original $5.25 million exemption. Potentially, her estate will have to pay millions of dollars in taxes that would otherwise have gone to her heirs.

On the other hand, suppose a widow inherits no exemption from her first spouse. If she remarries someone who has a $5.25 million exemption, and he dies first, the widow will inherit the $5.25 million exemption and her estate will potentially save a fortune in taxes.

Either way, this is something that should ideally be planned for before the widow or widower ties the knot.

For example, if a widow inherits a large exemption, and then marries someone with a much smaller exemption, she might want to make significant gifts of assets while she’s still alive, rather than leaving those same assets to her heirs in her will. Making gifts in this way can “use up” the inherited exemption, which would otherwise be lost if her new husband were to die before she did.

In addition to tax and financial planning, widows and widowers might also want to specifically address the issue of inherited exemptions in a prenuptial agreement.

For instance, a spouse can inherit an exemption only if the other spouse’s estate files an estate tax return. So a prenuptial agreement might require the spouses to state in their wills that their executor must file an estate tax return – even if no taxes are owed and a return isn’t legally necessary.