The procedure for probating an estate in Texas can be quite simple under the right circumstances. Typically, when a person in Texas dies with a valid Last Will & Testament in place (known as dying “testate”), the Will names a person or persons to serve as executor of the estate. If the Will states that the executor is to serve as an “Independent Executor” and there is a need to administer the estate, the process used most often is known as an “Independent Administration”. This is often the simplest and least costly way to administer an estate because it often involves only one trip to the probate court and minimal supervision by the court during the administration process. Once the application to probate the Will has been filed, there will be a hearing in front of the judge of the probate court (or County Court at Law) during which testimony will be given. Often, the person named as independent executor in the Will offers testimony at this proceeding. Following the hearing, assuming all of the requirements are met, the judge will sign an order admitting the Will to probate and appointing the Independent Executor of the estate. The Independent Executor will then take an oath and will be qualified to receive Letters Testamentary, which authorize the Independent Executor to act on behalf of the estate. In addition, the executor will be required to publish a notice to creditors and possibly send notices to the beneficiaries named in the Will. In addition, the executor will be required to file an inventory of assets of the probate estate. The advantage of an Independent Administration is that once appointed, the Independent Executor does not have to get court approval for most routine items involved in the administration of the probate estate. This differs from a dependent administration, in which the administrator may be required to obtain court approval before doing many things, such as selling or distributing assets of the estate.
Larger counties in Texas, such as Harris County and Travis County, have their own probate courts that handle matters such as the administration of estates and guardianships. For smaller counties, such as Fort Bend County and Montgomery County, County Courts at Law will conduct the probate hearings and oversee the administration of estates in their jurisdictions.
In addition to probating the estate of the decedent in a Texas court, there are also some federal income tax and federal estate tax issues that may need to be addressed. Generally, the executor named in the deceased person’s Will has the duty of ensuring that all necessary tax returns are filed in a timely manner. If the deceased did not have a Will, or the Will did not name an executor, the court will need to appoint a personal representative called an administrator.
One of the tax issues that needs to be addressed regarding a deceased person’s estate is the filing of the decedent’s final income tax return (IRS Form 1040). This final tax return will cover the period from January 1 through the date of death, and will be due on the same date as the return would have been due if the decedent had survived the entire year (i.e., April 15 of the year following the date of death).
After a loved one dies, it can take some time to administer the estate. In the meantime, assets held by the decedent may continue to accrue interest or generate income, which may necessitate the filing of an income tax return for the estate (not to be confused with a federal estate tax return, discussed below). Generally speaking, the estate’s initial income-tax year starts immediately following death, and if the estate has income of $600 or more in a tax year, it is required to file a tax return (IRS Form 1041) for that year. If the estate is administered relatively quickly, there will often not be a need to file a Form 1041 for the estate. If there is a need for this, the executor (or administrator) should seek the advice of a competent tax advisor experienced in filing these returns.
In addition to income taxes, there are potential estate tax ramifications for the estate of the decedent. If an estate is large enough ($5.34 million for 2014), there may be a need to file an estate tax return (IRS Form 706). There are a number of factors involved in determining whether an estate is large enough to owe estate taxes, and there may be instances where an estate tax return should be filed even if no estate taxes will be owed. It is important to consult with a competent attorney to determine if a Form 706 should be filed.
Spousal Portability Under the Estate Tax Law Passed in 2010
In December of 2010, President Obama signed new tax law into effect, which made some very important changes with respect to federal estate and gift taxes. One of these changes was an increase in the amount of the estate and gift tax exemption to five million dollars for an individual (ten million dollars for a married couple). Another important piece of this legislation was the introduction of “spousal portability”. This article offers a brief overview of the New Estate Tax Law, focusing on the creation and funding of “shelter” or “bypass” trusts and the new “spousal portability” law.
What is “Spousal Portability” under the Revised Estate Tax Law? Before the enactment of the new law, the gift and estate tax exemption of the deceased spouse could not be used by the surviving spouse. To ensure that the exemption amount of the first spouse to die, “bypass” trusts were (and still are) used to shelter the assets of that spouse from estate tax, up to the full exemption amount ($5 million for an individual in 2012). However, to ensure this result, prior planning was necessary in order to be certain that a Bypass trust was created upon the death of the first spouse. This planning takes place in the form of the creation of the Bypass Trust in the Will of the spouse or in a trust created by the spouses during their lifetimes. The assets in the Bypass Trust are then kept out of the surviving spouse’s estate when he or she dies. As discussed below, the use of Bypass Trusts is still a very common and effective estate planning technique because it offers advantages in addition to the potential estate tax savings.
Generally speaking, spousal portability doubles the amount of the surviving spouse’s available estate tax exemption without having to create a bypass trust at the death of the first spouse. In other words, the surviving spouse can utilize all of the remaining estate and gift tax exemption of the first spouse to die, and no advanced planning is necessary to take advantage of this feature. For example, assume Husband and Wife live in Texas and have a combined estate of $10 million, consisting entirely of community property. If Husband dies in 2012 and there was no tax planning done prior to his death in order to create a bypass trust to utilize his estate tax exemption, there would be no estate tax payable because of the unlimited marital deduction (which allows a deceased spouse to leave an unlimited amount to the surviving spouse tax-free). However, Wife would now have an estate of $10 million. So, if Wife died in 2012 when the exemption amount is $5 million and the estate tax rate is 35%, her estate would owe taxes on the remaining $5 million dollars, or roughly $1,750,000. This result could have been avoided by a minimal amount of planning before Husband’s death. However, thanks to the spousal portability provisions in the new law, Wife gets an opportunity to use Husband’s exemption that otherwise would have been wasted. While spousal portability is a good way to make up for a lack of prior planning, the portability is not automatic upon the first spouse’s death. The Executor of the estate of the first spouse to die must make an election on a timely filed estate tax return (IRS Form 706). The estate tax return must be filed even if there is no estate tax due, which means that married couples with smaller estates must file the return to take advantage of the portability feature. The estate tax return must generally be filed within nine months after the first spouse dies (up to fifteen months if an extension is filed). If this estate tax return is timely filed, the surviving spouse will be able to utilize any unused portion of the deceased spouse’s exemption amount.
So, Do I still Need Planning with a Bypass Trust?
With the advent of spousal portability, one common misconception is that bypass trusts are no longer needed. However, as discussed in more detail below, there are several reasons that bypass trusts should still be utilized in the estate plan of a married couple.
One issue in relying on spousal portability rather than planning with a bypass trust has to do with the appreciation of the assets in the deceased spouse’s estate. If the deceased spouse’s estate is left outright to the surviving spouse, then even if the spousal portability option is elected by the surviving spouse, the appreciation of those assets will be included in the estate of the surviving spouse when he or she dies. Using our example from above where Husband and Wife have a $10 million dollar estate, and Husband dies in 2012 leaving his $5 million to Wife, and Wife elects spousal portability, Wife’s estate will not owe any estate taxes on Husband’s $5 million when she dies. However, if Wife wisely invests Husband’s $5 million and it grows to, say, $7 million at the time of her death (and assuming she still has all of her $5 million from before Husband died), Wife now has an estate worth $12 million, of which only $5 million can be sheltered from estate tax (assuming Wife dies in 2012). After the use of her $5 million exemption, Wife’s estate would owe estate taxes on $2 million. However, if Husband’s Will had created a bypass trust to shelter his $5 million estate from estate taxes, those assets along with any post-death appreciation in those assets are removed from Wife’s estate and will not be subject to estate tax in the future. So, when Wife dies, the $2 million increase in value in the assets from Husband’s estate will not be taxable in Wife’s estate. This simple example illustrates how a minimal amount of planning can potentially save a large amount in taxes that would not have been achievable simply by utilizing the spousal portability feature in the new law.
Another important aspect of the spousal portability feature in the new law is that it does not provide the surviving spouse any protection from creditors. On the other hand, assets held in a bypass trust may be protected from creditors of the surviving spouse if the trust is drafted properly. This means that if Wife gets sued after Husband’s death or if other creditors seek to reach Wife’s assets, they may not be able to get to the assets held in the bypass trust. This can help ensure that Wife will have assets to use for her support even if her other assets are lost to creditors or otherwise spent.
In addition to the reason discussed above, there are other issues in relying on the spousal portability. While these other concerns are beyond the scope of this article, suffice it to say that there are issues with the spousal portability law with respect to Generation Skipping Tax (GST) issues, as well as remarriage of the surviving spouse. If the surviving spouse later remarries, he or she may be forced to use the new spouse’s spousal portability amount, if the new spouse predeceases. This amount may be less than the first spouse’s portability amount.
Despite some of the potential issues with spousal portability, it is still a way for married couples to take advantage of both spouses’ full exemption amount if there was no planning done prior to the death of the first spouse. Ultimately, there is no single solution for an estate plan that can be universally applied to all couples or families. In determining the optimal solution to an individual’s or family’s needs regarding estate planning, there are numerous factors that should be examined, and the tax implications are only one of the aspects that should be considered (although often a very important one).
Contact the Houston, Texas office of the Vance Law Firm today for a free consultation and evaluation of your estate planning needs and objectives.