What is Portability?
Portability is the use of a deceased spouse’s Estate tax exclusion amount by the surviving spouse.
You may be wondering, “what is an estate tax and why should you care about the Estate tax exclusion amount?” An estate tax is a type of tax that is determined by the net value of property a deceased individual owned at the time of their death. This Estate tax is subject to a “coupon” called the Estate tax exclusion amount. The Estate tax exclusion amount is applied towards the value of the net estate which allows a certain amount of an estate to pass to heirs without being taxed.
In 2016, the estate & gift tax exemption amount is $5.45 million (it is anticipated this amount will increase to $5.49 million in 2017) and the Estate tax rate is up to 40%. Therefore, if your deceased spouse’s estate is more than this $5.45 million Estate tax exclusion amount, the amount that exceeds the $5.45 million of his/her estate will be taxed at up to a 40% rate.
Example:
Olivia and Elliot are married and all of their assets are owned, jointly, with a net worth of $10,000,000. Neither Elliot or Olivia knew portability could be an option for their estate plan. When Elliot passes away all of the jointly owned assets will automatically pass to Olivia because these assets were simultaneously owned by both Olivia and Elliot so Olivia has a right to the assets by rights of survivorship. Since the assets are automatically transferred to Olivia, Elliot’s Estate tax exclusion will not be used since Elliot did not take advantage of portability or dispose of his assets through the Unlimited Marital Deduction.
The Unlimited Marital Deduction allows you to give an unlimited amount of your assets to your spouse, when you are alive or through your estate plan with no tax consequences. However, the left-over amount of assets not covered under the Unlimited Martial Deduction for the surviving spouse will be taxed. Thus, portability was enacted to solve this concern.
When Olivia passes away, the estate is still worth $10,000,000. Olivia’s estate is over the $5.45 million Estate tax exclusion amount and will be taxed the Estate tax rate of up to 40%.
Let’s do the math:
- $10,000,000 estate – $5,450,000 exemption = 4,550,000.
- $4,550,000 is the amount of the estate that is taxable, and will be taxed up to 40%.
- So, $4,550,000 x 40% = 1,820,000 amount of tax liability.
What if Elliot and Olivia knew about portability? Let’s find out.
Why consider portability?
When portability is included in your estate plan, portability allows you to transfer your unused tax exclusion amount to your surviving spouse without a trust. Why is this important? Because when a spouse passes away and their estate does not exceed the $5.45 million Estate tax exclusion amount, portability allows the deceased spouse’s unused Estate tax exclusion to be applied to the surviving spouse’s estate.
Let’s put this together:
As stated above, Elliot and Olivia own $10,000,000 worth of jointly, owned assets. Elliot has passed away and his estate does not exceed the $5.45 million Estate tax exclusion amount because all the assets are automatically transferred over to Olivia by rights of survivorship. Again, Elliot’s unused Estate tax exclusion amount is $5.45 million.
In this scenario, Elliot and Olivia took advantage of portability in their estate plan. Under portability, Elliot’s unused Estate tax exclusion amount will be added to Olivia’s original Estate tax exclusion amount of $5.45 million. Now, Olivia’s estate will have a total Estate tax exclusion amount of $10,900,000. When Olivia passes away her estate is still worth $10,000,000, but this time Olivia’s Estate tax exclusion amount is $10,900,000.
Let’s do the math:
- $5,450,000 Elliot’s unused exclusion + $5,450,000 Olivia’s exclusion = $10,900,000
- $10,900,000 Olivia’s new Estate exclusion amount – $10,000,000 Olivia’s estate = $900,000 lower than the Estate Exclusion amount
- The estate will save $1,820,000 that would have been taxed if the estate did not file for portability.
Therefore, Olivia’s estate will pass on the total amount of $10,000,000 free of federal taxes because portability doubled Olivia’s Estate tax exclusion amount which allowed Olivia’s estate to avoid federal Estate tax. When it comes to state taxes, only Hawaii recognizes portability. Now that you understand the what and the why of portability, let’s discuss the how, the who, and the when.
How, Who, and When can you apply for portability?
How? Portability is not an automatic election given to a surviving spouse. The estate must file a death tax return, known as an IRS Form 706.
When? The 706 must be filed within 9 months of the spouse’s passing.
Who can file the form? The personal representative of the estate. If the surviving spouse is the personal representative of the deceased spouse’s estate, the surviving spouse can file the 706 form.
Portability Quick Facts:
- If the surviving spouse is remarried, this new marriage does not affect the deceased spouse’s
- A surviving spouse only has the right to his/her most recently deceased spouse’s unused Estate tax exclusion.
- Late filing of the 706 form is sometimes allowed, but the fee for filing late is about $9,800.
- An extension for the election of portability may be granted if the IRS can be certain that the executor acted reasonably, in good faith, and that relief will not prejudice the government’s agenda.
- A martial agreement can include a provision to assure a portability election is made.
The process involved with portability is complex and can be tricky. Please consult an attorney to plan and draft your estate planning needs.