November 28, 2011
Authored by: Mark Newcomer and John Readey
The Penn State scandal has dominated media headlines in recent weeks. While the vast majority of the coverage has been directed toward the alleged criminal acts and potential cover-ups, there has been a fair amount of buzz surrounding Joe Paterno’s July 2011 transfer of his entire interest in his home to his wife for $1. Many have speculated that Joe Paterno had no legitimate reason to transfer sole ownership of the house to his wife, and that he must be trying to shield assets from potential civil litigation. While I will not speculate as to Joe Paterno’s rationale for making such a transfer, I believe it is incorrect to take the position that there is no legitimate reason for doing so. In many instances, spouses can reduce their potential estate tax burden by making inter-spousal transfers of assets.
The following is a simple example of how an inter-spousal transfer can accomplish a legitimate estate planning goal. Currently, each individual may exempt $5 Million of his or her assets from estate tax at death. Assume that husband has assets of $6 Million and wife has assets of $4 Million. In this scenario, $1 Million of husband’s assets could be subject to estate tax upon his death. On the other hand, wife would have $1 Million of unused estate tax exemption upon her death because she only has assets of $4 Million. Therefore, it may make sense for husband to transfer $1 Million to wife, reducing his estate to $5 Million and increasing her estate to $5 Million. This may help ensure that no estate tax would be due upon the death of either spouse.
It should be noted that recent legislation made possible the “portability” of estate tax exemption, which permits a surviving spouse to use his or her previously deceased spouse’s unused exemption. While portability may mitigate the potential estate tax problem addressed in the example above, it may not always provide maximum estate tax advantages. For example, if, in the example above, wife died first, she would have $1 Million of unused exemption. Assume husband lives for another 10 years, and, during that time, his assets grew from $6 Million to $9 Million, a 50% increase. Thus, the $1 Million husband could have transferred to wife to maximize her exemption grew to $1.5 Million, yet husband may only use wife’s $1 Million unused exemption against that $1.5 Million, and that difference of $500,000 will be subject to estate tax. If, on the other hand, husband had transferred $1 Million to wife, then all of the $500,000 gain in value of those assets would be exempt from estate tax (estate tax-exempt assets may grow, free of estate tax, after decedent’s death). Failure to transfer $1 Million to wife during her lifetime effectively increased the amount of husband’s estate subject to estate tax by $500,000, and at the current 35% estate tax rate, increased his estate tax liability by approximately $175,000. Therefore, ensuring that each spouse fully utilizes his or her estate tax exemption, if possible, is likely preferable to relying on portability.
Again, I do not want to speculate as to the rationale behind Joe Paterno’s transfer of his interest in his house to his wife, but, even with “portability”, there are legitimate estate planning reasons for making such an inter-spousal transfer.