Portability Ensures that Couples Receive Full Benefit of their Estate Tax Exemptions

The term “portability” describes a provision added to the federal estate tax law in 2010 that allows the surviving spouse’s estate to take advantage of any estate tax exemption that the deceased spouse did not use. Until the estate tax exemption was made portable, if the estate of the deceased spouse did not take full advantage of his or her individual exemption to pass assets to their heirs tax-free, the exemption was lost to the surviving spouse.

The concept of the portable estate tax exemption is relatively new and was only added to estate tax law for the 2011 and 2012 tax years by the 2010 Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act (TRUIRJCA), The 2013 American Taxpayer Relief Act (ATRA) made portability a permanent feature of the estate tax.

How Does the Portable Estate Tax Exemption Work?

The IRS has announced that for 2021 the federal estate tax exemption will be $11.7 million per individual, up from $11.58 million per individual in 2020. The estate tax only applies to transfers made between the deceased and someone who is not their spouse. The tax does not apply to assets transferred between the deceased and surviving spouse, regardless of the value of the transferred assets.

If the deceased spouse’s estate passed to the surviving spouse before 2011, there was no federal estate tax due, but the deceased spouse lost his or her federal estate tax exemption (sometimes known as the deceased spouse’s unused exclusion, or “DSUE”). The apparent unfairness of this situation was the reason much of the estate planning that took place before 2011 involved the transfer of a spouse’s assets to some type of trust when he or she died. That allowed the estate to claim an exemption for the transfer that would be unavailable to the surviving spouse.

With the portability provisions in place, the surviving spouse can take advantage of the unused portion of the predeceased spouse’s exemption. As a result, a married couple who simply allow their spouse to inherit all of their assets without any additional estate planning is not penalized for doing so.

To see the impact of estate tax portability, consider the following scenario with and without portability:

Without Portability: A couple with a combined net worth of 20 million leave their assets to the surviving spouse upon their death. One spouse dies in 2020, leaving the surviving spouse with assets of $20 million. There would be no estate tax due on the transfer of the assets to the surviving spouse. When the surviving spouse died in 2021 she had assets of $20 million that were distributed to her heirs. If there was no estate tax exemption portability, $11.7 million of her estate would be passed to her heirs tax-free, while the remaining $8.3 million would be subject to the estate tax at the 40% rate. As a result, the surviving spouse’s estate would be responsible for paying $3.32 million in estate taxes.

With Portability: If the above situation occurred with the portable estate tax exemption, the surviving spouse could take advantage of the $11.58 million exemption available to the predeceased spouse’s estate in 2020. That would give the estate of the surviving spouse a combined $23.28 million exemption because it could take advantage of the predeceased spouse’s $11.58 million exemption from 2020 plus $11.7 million exemption at the 2021 rate. Since the exemptions’ combined value exceeds the $20 million in assets in the estate of the surviving spouse, the passing of her assets would not incur any estate tax. Portability saved the couple’s combined estates $3.32 million in taxes.

You Must File a Return to Take Advantage of Portability

One of the advantages of having a large exemption is that most estates need not file an estate tax return. However, to take advantage of portability, the estate of the first spouse to pass away must file a Form 706 estate and generation-skipping transfer tax return that makes the portability election. Form 706 must be filed nine months after death unless an extension is filed.

Even if you think you and your spouse will never have more than $11.7 million in combined assets, it is important to take this step if you have significant assets. Among other things, there is a high likelihood that the individual estate tax exemption will fall by half 2026. The current $11.7 million estate tax exemption is the result of the  2017 Tax Cuts and Jobs Act (TCJA) doubling the size of the exemption. Before the act’s passage, the exemption was $5.49 million per taxpayer. The TCJA is set to expire December 31, 2025, and unless Congress acts, the exemption will return to its pre-2017 rate (adjusted for inflation).

Code Accounting Can Help with Estate Planning

With the current estate tax exemption at $11.7 million, many couples assume that they do not need to develop an estate plan because they will not face the estate tax. However, given the possibility that the exemption could drop by roughly 50% in 2026, it is a good idea to plan ahead and make sure that you have taken every possible step to minimize your estate tax obligations. If you live in the Bay Area, the skilled financial professionals at Code Accounting can review your estate plans to ensure they take full advantage of both the estate tax exemption and portability.

Categorised in: Planning

This post was written by Sean Allaband