Federal Estate Tax Exemption Increases; Tennessee Inheritance Tax "GAP" Increases Dramatically

The federal estate tax exemption will increase from $2,000,000 to $3,500,000 for decedents dying on or after January 1, 2009.  The unlimited marital deduction remains in effect.  An individual, therefore, may pass an unlimited amount to his or her surviving spouse upon his or her death and up to $3,500,000 to non-spouse beneficiaries without paying any federal estate tax.  Under current law, the federal estate tax exemption amount will remain $3,500,000 for the 2009 tax year and, in 2010, the federal estate tax will be repealed for one year.  In 2011, the tax returns with an exemption of $1,000,000.  As discussed above, however, President-elect Obama has proposed freezing the federal estate tax exemption at $3,500,000.

The federal exemption amount was as low as $600,000 in 1997 and $1,000,000 as recently as 2003.  Many estate plans developed and implemented in 2003 and before for married couples provide that upon the death of the first spouse, an amount equal to the exemption amount to be set aside in a family trust for the benefit of the spouse and children with the amount in excess of the exemption to be distributed to the surviving spouse (either outright or in trust).  The family trust is designed to avoid the federal estate tax on the amount in the family trust upon the death of the surviving spouse.  If a married couple has this type of plan in place today and their combined assets (including the death benefit from any life insurance) are less than $3,500,000, they should consider simplifying their wills since the family trust is not necessary upon the death of the first spouse to avoid estate tax upon the second death.  Married couples for whom this type of planning is still appropriate may want to consider capping the amount available to fund the family trust to insure the surviving spouse receives sufficient assets.

The exemption for the Tennessee state inheritance tax remains unchanged at $1,000,000, which is $2,500,000 less than the current federal estate tax exemption of $3,500,000.  This substantial difference is sometimes referred to as the “Tennessee gap.”  The Tennessee exemption and the federal exemption were the same amount until 2003 so that any amount passing into a family trust upon the death of the first spouse under the planning described in the preceding paragraph would have been exempt from both the Tennessee inheritance and the federal estate taxes at the death of the surviving spouse.  These types of estate plans now result in Tennessee inheritance tax being due upon the first-to-die of a married couple since an amount in excess of the Tennessee exemption (i.e., the “Tennessee gap”) passes to the family trust and not to the surviving spouse.  The amount of the Tennessee inheritance tax that would be due in 2009 upon the first-to-die in an estate with this type of planning is $225,900.  These types of estate plans for married couples should be revised to defer this Tennessee inheritance tax to the time of the death of the surviving spouse.