Portability has become an important tool for most couples when it comes to estate planning. The selection of its timely use is important to understand. Let’s take a look at the opportunities portability has to offer.
Portability arrived on our doorstep courtesy of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. It allowed the “portability” of any unused applicable exclusion amount from a deceased spouse to the surviving spouse. The applicable exclusion is the umbrella covering each person to offset possible federal estate or gift tax. It can be utilized during life to offset gift tax, or at death to offset any federal estate income tax.
The current amount of applicable exclusion is $5,340,000 and will change each year by an inflation index.
Before 2011, without portability, to achieve the same estate tax savings, credit shelter trusts were absolutely necessary. Now, at the passing of the first spouse, an election can be made within the Federal Estate Tax Return, Form 706, to transfer the deceased spouse’s unused applicable exclusion to the surviving spouse.
The Internal Revenue Service will allow portability to be elected on a late filed federal estate tax return in the case of predeceased spouses passing away in 2011, 2012, or 2013 as long as the federal estate return is filed prior to December 31, 2014.
Assume a couple owned $6 million in assets where each spouse possessed an individual $3 million estate in joint tenancy. At the death of the first spouse, his/her assets transfer to the surviving spouse resulting in the surviving spouse now having a $6 million estate. With portability of the unused applicable exemption, the surviving spouse has a total $10.68 million exemption and a $6 million estate, resulting in no federal estate taxable exposure. Without use of portability, the surviving spouse would have a $6 million taxable estate, and the only exemption remaining would have been $5.34 million, producing a taxable estate of $660,000. The tax rate of 40% would be applied to this excess resulting in federal estate tax of $264,000.
The portability election is not without some negative attributes. By making the portability election at the death of the first spouse, the statute of limitations does not close on the first spouse’s estate until the death of the surviving spouse. Consequently, the Internal Revenue Service has the ability to re-examine any issue in the estate of the first spouse. Also, if the descendent resides in a state which still has state inheritance tax, many times the applicable exemption for the state may not be the same as the federal.
The advantages of portability are many. The first is the ability to utilize the remaining spouse’s unused applicable exclusion in the surviving spouse’s estate without necessarily having to put assets into a credit shelter trust. This advantage will many times outweigh the disadvantages. As the example above demonstrates, the federal estate tax savings can be substantial.