The American Tax Relief Act of 2012 (ATRA) introduced us to extended opportunities to use “Portability” as part of the estate tax unified credit. As part of the estate tax code, each person has a lifetime exemption from gift and estate tax called the “unified credit” (see my post on tax-free gifting). In 2021 the unified credit is $11.7 million. However, a revision of the unified credit is part of President Biden’s proposed tax bill for 2022, which would reduce the exemption to $3.5 million.
If not properly planned, the probate requires that all marriage assets be given to the surviving spouse. By doing this the exemption of the deceased spouse is lost and now only half as many assets can be transferred to the next generation without incurring a tax.
However, Portability provides a last chance to save the deceased spouse’s exemption to be used in the future by the surviving spouse when he/she passes away. By electing portability, the surviving spouse can keep the deceased spouse’s exemption, to be used in the future, either for lifetime gifts or at the death of the surviving spouse. But there is only a small window of time where the surviving spouse can elect to use Portability. In order to elect portability an estate tax return (IRS Form 706) electing portability must be filed timely (9 months from the date of death) after the deceased spouse’s death.
What if you do not have a taxable estate? Even if your estate is not a taxable estate now, it may be in the future, either through continued growth of assets, or by changes in the tax law. Therefore, even if you do not have a taxable estate now, it is important and smart to file an estate tax return and elect Portability. By doing so, you will save the deceased spouse’s exemption for the future, if needed.
Example (Married Couple):
- Estate worth $6 million in 2021; Estate tax exemption is currently $11.7 million per spouse.
- No estate planning has been done.
- Husband dies in 2021.
- President Biden proposed tax bill passes in 2022 reducing exemption to $3.5 million.
- Wife dies in 2026. The assets of the estate have grown in value to $10 million.
- Adjusted for inflation the estate tax exemption is $4 million in 2026.
Portability not Elected
In this scenario, the estate is not taxable in 2021. Between the two spouses they can pass up to $23.4 million dollars of assets on to children with no estate taxes, and so they do not do any estate planning. However, since no estate planning has occurred, everything is going to go to the Wife, and the Husband’s exemption is lost. The Wife does not believe there is a problem because, in 2021, the Wife has an estate worth $6 million, but $11.7 million of unified credit to use. Therefore, Portability is not elected.
However, the next year, the proposed tax law is passed by Congress and the exemption is reduced. The Wife’s expenses are similar to before and the marital assets continue to grow in value. By the time the Wife passes away, the estate is worth $10 million, but now she only has her own $4 million of exemption because the Portability was not elected at the Husband’s death, and the Husband’s exemption was therefore lost. $6 million of the estate is now liable to the estate tax. At the current 40% rate, the tax liability would be around $2.4 million.
If, instead, the Wife filed a timely estate tax return in 2021 when Husband passed away, she would be able to keep the Husband’s $11.7 million exemption from 2021. Therefore, when the Wife passes away, the estate is still worth $10 million, but she has her own exemption of $4 million plus the ported exemption of the Husband of $11.7 million, equaling a total of $15.7 million of exemption. The entire estate is therefore exempt from the tax, and the beneficiaries are $2.4 million wealthier.
It may be a simple thing that costs a few hundred dollars to file, but timely electing portability on an estate tax return could end up saving your family millions of dollars, even if you do not have a taxable estate right now. Make sure to speak with a certified specialist in estate planning, when a loved one has passed away to make sure that you are taking advantage of all you can.