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July 8, 2022

How Portability Can be a Valuable Estate Planning Tax Strategy

Good news came for taxpayers with large estates when the Tax Cuts and Jobs Act (TCJA) was passed. The TCJA doubled the estate and gift tax lifetime exemption, from $5.49 million per taxpayer to $11.18 million per taxpayer. For 2022, the exemption has been adjusted for inflation to $12.06 million per taxpayer and $24.12 million per married couple. On top of this generous amount, the IRS also allows for portability of the exemption between spouses – an important consideration in estate planning.

What is the lifetime exemption?

The lifetime exemption refers to the amount the IRS allows you to exclude from your gross estate when calculating your estate tax. This exemption means that should both spouses pass away in2022, they have the potential ability to pass on $24.12million to their heirs tax-free. However, this amount can be reduced by gifts given from your estate during your lifetime. For example, gifts given to any one person over $16,000, applicable for the tax year 2022, will reduce the exemption by the amount over $16,000, whereas the payment of medical, dental, or tuition expenses will not reduce your exemption.

Where does portability come into play?

Prior to 2010, any amount of the lifetime exemption that went unused by an estate was simply lost. A large component of estate planning involved married couples trying to split the ownership of the estate’s assets as evenly as possible. For example, say the lifetime exemption is $3 million and a married couple had an $8 million estate. The wife passed away first with only $2 million of those assets in her name. Her assets would be sheltered by her lifetime exemption, but she would lose the exemption amount that went unused. When her husband passes with $6 million in assets, he would only be able to shield $3 million of his assets and the rest would be subject to the estate tax. If the couple were to each own about 50% of the assets, the potential to waste any unused exemption amount would have been greatly reduced.

However, when the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 passed, it allowed for portability. This term refers to the ability to transfer that unused portion to the surviving spouse, referred to as the deceased spouse’s unused exemption (DSUE). This transfer is accomplished by completing the election on the Form 706 Estate Tax Return and can be completed without regard to the legal ownership of each spouse.

Calculating the DSUE is simple. The DSUE will be equal to the unused amount from the year the spouse passed away, based on the inflation-adjusted exemption from that year. When the surviving spouse passes, their exemption will be the DSUE plus the exemption for that spouse in the year of their death.

Are there any caveats to the DSUE?

Form 706

To use the DSUE, the estate must timely file an Estate Tax Return when the first spouse passes away, and the “portability” election must also be properly completed. These steps could be easily overlooked since an Estate Tax Return does not necessarily have to be filed if the estate is below the exemption amount. The original due date of an Estate Tax Return is 9 months; an extension can be filed for an additional 6 months. As of July 8, 2022, the IRS has decided to grant relief for late filing up to 5 years if the return is being filed exclusively for portability.

Second Marriages

The IRS has imposed a “last deceased spouse rule”, meaning that if a taxpayer had a DSUE and then subsequently remarries, they forfeit the first DSUE in the event their second spouse passes away. There are some tax planning strategies that can be used to protect the first DSUE. One potential tactic is to use up the DSUE through gift giving by using it as a shield for gifts given over the annual limit of $16,000. The DSUE will be reduced before it becomes unusable, and the taxpayer will not have to pay taxes on these gifts. Portability agreements can also be written into a marital agreement.

What are some considerations for taxpayers in their estate planning?

Married couples should first consider what the expected value of their estate will be over the lifetime and if they expect their estate to be subject to estate taxes.

Taxpayers should also be aware that currently, the $11.18 million exemption amount is set to expire in 2026. There has been concern that there could be adverse effects to an estate who gave gifts in years when this exemption was in place, but the taxpayer passes away after the expiration date and the exemption amount drops. The IRS has consequently included a rule stating that an estate will essentially be allowed to determine its tax based on the $11.18 million exemption amount, rather than the exemption in place at the time of death in most cases.

It’s important to work with a trusted advisor on developing your estate plan. Anders has Family Wealth and Estate Planning advisors that can help ensure you and your family are preparing for the future. Contact an Anders advisor below to learn more.

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