Portability: The Tax Election Every Surviving Spouse Must Consider

The Federal Estate Tax exemption for 2014 is $5.34 million.  This means that if a decedent’s gross estate (plus past taxable gifts) is less than $5.34 million then filing a Federal Estate Tax Return (Form 706) is not required.  However, a surviving spouse should always consider the option of electing to file a Federal Estate Tax Return.

Portability Introduced in 2011

Prior to 2011, a decedent’s unused exemption could not be transferred to a surviving spouse.  Estate tax exemption was purely a “use it or lose it” proposition.  That all changed under the 2010 Tax Act when the concept of “portability” of unused exemption was introduced.  The portability election allows a surviving spouse to increase his or her gift/estate tax exemption by the amount of the deceased spouse’s unused exemption amount ( the “DSUEA”).  The unused exemption amount for a deceased spouse is (for 2014) $5.34 million minus the value of all property passing to anyone other than the surviving spouse.

Consider an Example

Husband (H) dies in 2014 with a gross estate of $5 million.  H leaves $500,000 to his children and the remaining $4.5 million to his Wife (W).  A Federal Estate Tax Return is not required to be filed because his $5 million gross estate is less than the $5.34 million exemption amount.  However, W may optionally file a Form 706 to elect to increase her exemption by H’s $4.84 million unused exemption ($5,340,000 minus $500,000). Assume W also has her own separate assets of $4 million and when W dies in 2018 her total $8.5 million estate has grown to $10 million, and the indexed applicable exemption has grown to $5.5 million.  Will W’s estate owe federal estate tax?

• If W filed a portability election after H’s death:  W’s estate can claim an exemption of $4.84 million (H”s unused amount) plus the then current $5.5 million, for a total exemption of $10.34 million.  Since her $10 million estate is less than the total claimed exemption, no federal estate tax is due and the entire estate passes tax-free to her beneficiaries.
• If W did not file a portability election after H’s death: W’s estate can only claim her $5.5 million exemption.  W’s taxable estate is $4.5 million ($10 million minus $5.5 million).  W’s estate will owe federal estate tax equal to 40% of that amount: $1.8 million.
  

Potential Huge Tax Savings

You can easily spot the upside of filing a federal estate tax return to elect portability.  In this example, it’s $1.8 million of tax savings.  So what’s the downside or risk?  From a tax perspective, none.  Filing to claim portability can only save tax down the road.  The only downside to the election is the time, effort and cost to prepare and timely file the 706.

The decision is likely to rest on the perceived likelihood that the extra exemption will be needed in the future.  Relevant factors include the surviving spouse’s age, investments, business interests and inheritance prospects.  For example, if the survivor is in her 80’s with a small estate consisting of fixed income assets and little prospect of substantial inheritance, then it’s highly unlikely that the extra exemption will be needed, short of winning the lottery.  On the other hand, if the surviving spouse is in her 50’s with significant assets, investments or an active business, then filing a timely election on a 706 is the prudent choice.  This is a decision that every surviving spouse should discuss with his or her attorney during the estate administration process.

Timing is Critical

Timing of the portability election is critical.  The deadline for making the portability election is 9 months after death, plus another 6 months if an extension request is filed (15 months total).  In the near future, I will highlight a special one-time extension of this deadline recently announced by the IRS available for 2011 through 2013 decedents.

Note: Portability applies only to Federal Estate Tax exemption.  It does not apply to Illinois Estate Tax or to Federal Generation-Skipping Transfer Tax.

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