New estate tax law affects widows and widowers who remarry

Widows and widowers who are considering remarriage should be aware that a new federal tax law could potentially 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 this new law gives added urgency to this rule, because it potentially could result in huge additional taxes – or tax savings – and planning for this possibility is essential.

Generally, 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 2012, the exemption amount is $5 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 get her own exemption amount.

But under the new tax 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. So suppose a husband dies and doesn’t use any of his $5 million amount (because he leaves everything to his wife). When the wife dies, her exemption amount will be her own $5 million plus the $5 million that the husband didn’t use. So instead of being able to leave $5 million tax-free to her heirs, she can leave $10 million tax-free – a potential savings of millions of dollars.

So 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 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 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 million exemption, and he dies first, the widow will inherit the $5 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.

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.

Future changes?

As things stand now, the law about inherited exemptions expires at the end of 2012. But there’s a good chance that Congress will extend it, so it’s wise to make plans regarding it.

The $5 million exemption amount is also scheduled to expire at the end of 2012, and it’s not clear what will happen after that. It appears that if Congress does nothing, the exemption amount will reset at only $1 million starting in 2013. This fact alone makes estate planning now all the more vital.

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