A federal estate tax return doesn’t have to be filed every time someone dies. In fact, a return typically doesn’t have to be filed unless the estate is worth more than the federal estate tax exemption amount (which is currently $5,340,000). As a result, most estates never have to file one. However, a change in the law back in 2011 makes it advantageous to file a return if the deceased person is survived by a spouse – even if the estate is below the exemption amount and thus a return isn’t legally required.
If you know someone whose spouse passed away and who didn’t take advantage of this opportunity, the IRS is now giving them a second chance to file a return – but they must act by the end of this year in order to do so.
Here’s the background: Generally, when a person dies, his or her estate can give an unlimited amount to a surviving spouse tax-free. After that, if the person’s bequests (plus large lifetime gifts) total more than the exemption amount, then an estate tax is due.
Traditionally, 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 get her own exemption amount. But if the husband left everything to his wife and no tax was due when he died, the husband’s exemption amount would be “wasted.”
Under a change in the law starting in 2011, 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.
So suppose a husband dies and doesn’t use any of his $5,340,000 amount (because he leaves everything to his wife). When the wife dies, her exemption amount will be her own $5,340,000 plus the $5,340,000 that the husband didn’t use. So instead of being able to leave $5,340,000 tax-free to her heirs, she can leave $10,680,000 tax-free – a potential savings of millions of dollars.
However, this only works if the husband’s estate filed a federal estate tax return and elected to pass the exemption amount on to his wife. If the husband’s estate didn’t file a return (because it wasn’t legally required), then all the potential tax savings are lost.
This means that it’s almost always a good idea to file an estate tax return for anyone who dies and is survived by a spouse.
Even if it seems highly unlikely that a surviving spouse will be worth more than $5,340,000 when he or she dies, it’s still a good idea to file a return, because Congress could always change the exemption amount. In fact, not that long ago the exemption amount was less than $1 million.
Recently, the IRS announced that for anyone who died between the beginning of 2011 and the end of 2013 and whose estate didn’t file a federal return, the estate can go back now and file one. Even though the return will technically be late, this will be allowed and there will be no penalty.
However, this window is open only until December 31, 2014. So if you know someone who is in this situation, be sure to encourage them to file a return.
Also, don’t wait until December! Act as soon as possible, because it can take some time to file a return properly, and you don’t want to be caught up in an end-of-the-year rush.
(Finally, you should be aware that there are further complexities involving the exemption amount if the surviving spouse decides to remarry. It’s important to discuss this with an estate planner if this is a concern.)