Portability in Estate Planning

Portability is a rather new concept in the world of estate planning, specifically regarding the Federal estate transfer tax. Before explaining what portability is and how it fits into your estate plan, let me explain a few things about the Federal estate and gift transfer tax system. A tax may be assessed on the transfer of property either by gift or by testamentary transfer. The tax is calculated on the value of the transfer, either on the date a gift is made or on the date of death. A tax is due and payable only when the combined value of the gifts and testamentary transfers exceed what is called the applicable exclusion amount. In 2016, the applicable exclusion amount for an individual is $5.45 million. The only wrinkle with the applicable exclusion is that it is personal to the individual taxpayer. Before 2012, this could present a problem where you have a married couple where one spouse holds most if not all of the assets – if the poorer spouse died first the richer spouse lost the ability to use the deceased spouse’s unused applicable exclusion when he or she passed. Enter portability.

 
Portability allows a surviving spouse to preserve any unused portion of a deceased spouse’s applicable exclusion for estate and gift transfer tax purposes (called the deceased spousal unused exclusion or DSUE by the Code). Individually, a taxpayer’s taxable estate must exceed the applicable exclusion amount of $5.45 million to be taxable. With portability, a married couple can shield a combined taxable estate exceeding $10.9 million for the estate or gift transfer tax purposes. For most people, their estate will not get within a mile of exceeding $5.45 million but even so portability still has legs. Consider the following example.

 
Let’s say a couple has an estate valued at less than the exclusion amount – we will use $4 million – with most of the assets held by the husband. The wife unfortunately passes away before the husband, leaving him holding a $4 million dollar estate. If he lives long enough, his estate might substantially increase in value, he may win the lottery or secure a large court judgment potentially pushing his estate over the $5.45 million threshold. Without portability, he would only have his individual $5.45 million with which to shield his estate from tax. With portability, however, he can combine his applicable exclusion amount with his wife’s unused exclusion amount to potentially shield up to $10.9 million from the estate transfer tax. Portability is only one of many tools to reduce an individual’s potential estate transfer tax liability but but it is comforting to know that portability is available to provide wiggle room.

 
Portability is not automatic, however. The deceased’s personal representative must timely file a complete and accurate Form 706, which is due 9 months after the date of death (though an extension to file may be requested), and make an irrevocable election regarding portability. Once that’s done, whenever the surviving spouse makes a gift or testamentary transfer, the deceased spouse’s unused exclusion will be used up first before dipping into the surviving spouse’s applicable exclusion amount.
Care must be taken in situations where the surviving spouse remarries. The unused exclusion amount that can be tapped into is for the last deceased spouse, per the IRS regulations. This means that if the surviving spouse remarries and the second spouse dies then any remaining unused applicable exclusion amount from the first spouse is lost. Thereafter, the surviving spouse can only tap into any unused applicable exclusion amount from the second to die spouse, if any (assuming a proper election is made by the personal representative).

 
This is a simple explanation regarding portability and there is a lot more that can be said on the subject. If you think portability may apply to your situation, please speak with your tax adviser to ensure you qualify.