This return is due nine months after death with a six-month extension allowed. If the executor doesn't file the return or misses the deadline, the spouse loses the right to portability. Spouses should file it even if they're not wealthy today, because someday, who knows?
For example, let's say Harry has an unused exemption amount of $2 million when he dies next year (say because he left $3 million to his children outright). His widow Sally has a $5 million exemption amount of her own. As the executor of Harry's estate, Sally can file a return, transferring Harry's unused exemption, so that she will then be able to pass $7 million tax-free (her own $5 million exemption plus Harry's $2 million unused exemption).
Is the amount that's portable adjusted for inflation? No, but the surviving spouse's own exemption amount is after 2011.
What happens if you remarry? This is where things may get complicated. Let's say that after Harry's death, Sally marries Joe. The law clearly indicates that she can only use the exemption amount of the husband who died most recently. So if Joe, her second husband, dies before Sally, he becomes the husband who died most recently. In that case she can no longer use Harry's exemption--only Joe's. If Joe's unused exemption is less than Harry's (or if he has no unused exemption at all), Sally is out of luck.
What if Sally dies first? Sally came into the marriage with a $7 million exemption amount, including the $2 million unused exemption from Harry. Assume she leaves $3 million to the children she and Harry had together. Posing a similar situation, a report by the Joint Committee on Taxation indicates that Joe can use the remaining $4 million exemption, along with his own.
Can I use my exemption instead to provide for children from a previous marriage? Yes. You can do this with just part of your exemption amount-or the whole thing-by leaving assets to them outright or in a bypass trust.
Is this a subject that should be covered in prenuptial agreements? Macabre as it may sound, inheritances often are the subject of prenups, especially when there are children from a previous marriage. And wills often specify the funds from which estate taxes should be paid (for instance, it's not tax efficient use retirement assets for this purpose). So while this is certainly a new topic, if it concerns you, it's something you should address.
Does portability also apply to the exemption from generation-skipping transfer tax? No. This tax applies, on top of estate or gift tax, to assets given to grandchildren (or to trusts for their benefit). Although there is no portability at death, for transfers during life married couples can combine each of their exemptions to give away a total of $10 million without incurring the tax.
Do I still need a bypass trust? The trust has the advantage of sheltering appreciation and could also be helpful in situations where you want to protect assets from creditors or benefit children from a previous marriage. But for most other cases, where couples have combined estates of $10 million or less, they might be better off just leaving everything outright to each other in what is called an "I love you will."
When outright bequests to the surviving spouse make sense for estate tax reasons, there may also be income tax benefits down the line. When the second spouse dies, these assets, included in her estate, get an adjustment in basis to their date of death value, which minimizes the capital gains tax heirs must pay when they are sold. In contrast, the basis on assets that went into the bypass trust when the first spouse died will not have changed since then.