Finally! Clarity in the Estate Tax! Sort of.

First of all, Happy New Year to everyone. We have 351 days left to make this year a success.

Now to the immediate matter at hand. As you may have heard, Congress has finally acted on the estate tax, passing a bill that levies a tax on estates greater than $5 million at a maximum 35 percent rate. That means that if your estate is worth less than $5 million, and almost everyone's is, you don't have to worry about this tax. At least for the next two years. Yes, rather than passing a permanent tax bill, the government instead passed a temporary bill that expires in 2012, at which time, the pre-2001 law ($1 million exemption [adjusted for inflation from 2001], maximum 55 percent rate) comes back into effect unless Congress does something. Again.

Now, why would our government pass a tax bill that was set to expire in 2012? I can't think of anything in particular that's happening in 2012. Please email me with your ideas.

Anyway, one aspect of this temporary bill is a thing called "portability." In short, in every married couple, each spouse has a separate estate tax exemption. Under portability, the surviving spouse can apply the unused portion of the deceased spouse's exemption to his or her estate when he or she dies. Unless the law changes. Or the surviving spouse gets remarried. Maybe.

To illustrate, let's say Spouse One and Spouse Two have a total estate of $3 million, all community property. Spouse One dies with an estate worth $1.5 million. The remaining $3.5 million can be used by the surviving spouse when he or she dies, for a total exemption of $8.5 million. One catch is, the surviving spouse has to die while there is still a portability law on the books. So, if this law expires after 2012, the surviving spouse loses the additional $3.5 million exemption. Another catch is if the surviving spouse remarries and then outlives his or her second spouse. This apparently immortal surviving spouse can now only use the portability of the second deceased spouse. So, if the second deceased spouse dies with an estate worth $5 million, the hearty surviving spouse gets no additional exemption.

We should all have these problems. There are many esoteric arguments being made about how best to address the potential traps in portability. One such "trap," using the example above, anticipates the surviving spouse wins the lottery, makes lifetime gifts of $8.5 million assuming they can be made tax free, and then the law expires, or he or she gets remarried and loses the portability. Most people don't make $8.5 million in lifetime gifts, even if they have the money, so this is a planning argument that most likely will occur only in a vacuum. Or a CLE presentation.

The bottom line is, most estates will not be taxable with a $5 million exemption amount. Or even a $1 million exemption amount. Most people don't win the lottery. So, portability won't mean anything to most people. As estate planners, the best we can do is understand the issues and plan for them as they come up. Your typical client with an $800,000 estate is likely not going to need to plan with portability in mind, and will not be affected if the $1 million exemption (adjusted for inflation from 2001) comes back in 2013.

So read the new tax law, understand it, and move on. There are more immediate issues that most estates must deal with. Like family dynamic.