For several years now, we have been hearing about “portability.” Do you know what it means? How does the term affect you?
Simply stated, portability of the federal estate tax exemption between married couples means that if the first spouse dies and the value of the estate does not require the use of all of the deceased spouse’s federal exemption from estate taxes, then the amount of the exemption that was not used for the deceased spouse’s estate may be transferred to the surviving spouse’s exemption so that he or she can use the deceased spouse’s unused exemption plus his or her own exemption in effect when the surviving spouse later dies.
Portability is not available for state estate taxes, but only applicable to federal estate taxes.
While the first deceased spouse’s estate may be less than the amount required to file a federal estate tax return, consideration should always be made to preserve the unused portion of the exempt as one does not have a crystal ball to know the circumstances at the time of the second spouse’s passing. There are any number of scenarios which may be present – perhaps the surviving spouse won the lottery, perhaps there was a legal settlement to which the surviving spouse was entitled – just to name a few.
The surviving spouse does not automatically “inherit” the first spouse’s unused exemption, but instead the personal representative of the first spouse’s estate must timely file IRS Form 706, United States Estate (and Generation Skipping Transfer) Tax Return, in order to make an affirmative election. If the surviving spouse is not the personal representative, the spouse should make certain that the personal representative files a Return (Form 706) to preserve the election.
Currently and most likely through 2025, the federal exemption amounts are relatively high – around $12 million at the time of this writing. But, after 2025, the amount is set to be reduced to an amount yet to be determined. Most tax professionals are guessing that the amount will be somewhere in the $5-6 million range, but there is nothing cast in stone.
So, while you may think that you needn’t pay attention to portability while your spouse is living, it is definitely something to keep in mind if your spouse should pass.
Let’s look at a few very simple examples:
- Xavier and Cleopatra are husband and wife. Xavier has reportable assets of $3.5 million for federal estate taxes. Cleopatra has assets of $4 million.
- If Xavier dies with a taxable estate of $3.49 million, the estate is not subject to federal estate tax. Rather than lose the unused portion of the available exemption (in 2023 the full exemption is $12,920,000), $9,430,000 would be available for portability use upon Cleopatra’s passing.
- Now, let’s look at the scenario at the time Cleopatra dies after 2025. Her estate at the time of her death (which includes the assets inherited from Xavier) is $9 million.
- If portability of Xavier’s unused exemption was not elected, Cleopatra’s estate tax would be based upon the following:
- $9 million in assets less the federal exemption $5-6 million (exact amount not available at this time) would leave a taxable federal estate of $3-4 million to be taxed at a rate of what could be 40 percent.
- That would mean that Cleopatra’s estate could pay around $1.5 million in estate taxes.
- If portability of Xavier’s unused exemption was elected, Cleopatra’s estate tax would be based upon the following:
- $9 million in assets less the federal exemption of $5-6 million (here again, exact amount not available at this time) less portability of Xavier’s unused exemption of $9,430,000 would eliminate a federally taxable federal estate.
- If portability of Xavier’s unused exemption was not elected, Cleopatra’s estate tax would be based upon the following:
You make the call. Is portability worth filing a return? Perhaps you need to have a discussion with your team – attorney, accountant, financial advisor – before you are faced with a decision. After all, no one has a crystal ball on taxes!