Portability allows the estate of a decedent who is survived by a spouse to make an election to permit the surviving spouse to apply the decedent's unused exclusion (the deceased spousal unused exclusion amount (DSUE)) to the surviving spouse's own transfers during life and at death. Effectively, portability allows both spouses to transfer a combined estate of double the usual $5 million exclusion (plus the inflation adjustment) estate and gift tax free.
Understanding portability is crucial to the surviving spouse’s estate planning opportunities.
Explanation of Portability. In general, the estate tax is imposed on a decedent’s gross estate as increased by the decedents’ taxable lifetime gifts, and reduced by any allowable estate tax deductions, such as the charitable or marital deduction. A tax of up to 40% is imposed on the resulting amount that exceeds the applicable exclusion amount.
Prior to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act) it was possible for a married couple to waste the applicable exclusion amount of the first spouse to die. Consequently, the 2010 Tax Relief Act introduced the concept of “portability” with respect to the unused portion of the applicable exclusion amount of a predeceased spouse, referred to as the DSUE amount. The American Taxpayer Relief Act of 2012 then made portability permanent.
For estates of decedents dying after 2010, the applicable exclusion amount is equal to the sum of the basic exclusion amount and any available DSUE amount, if previously elected. The basic exclusion amount is $5 million. The exclusion is adjusted for inflation and has risen to $5.43 million in 2015. A “portability election” passes along a decedent’s unused estate and gift tax exclusion amount to a surviving spouse.
Example. Husband died in 2011 with a taxable estate of $3M. An election is made on his estate tax return to permit Wife to use any of his unused exclusion amount. Wife, who had not made any lifetime taxable gifts, dies in 2012 with a taxable estate of $10M. The executor of her estate computes her deceased spousal unused exclusion amount to be $2M. Accordingly, the total applicable exclusion amount available to Wife’s estate at her death is $7M: her basic exclusion amount of $5M, plus $2M in deceased spousal unused exclusion from Husband’s estate. Wife’s estate owes estate tax of $3M * 40% = $1.2M rather than the $5M* 40% = $2M her estate would have owed without portability.
Use of the DSUE amount by the surviving spouse. The surviving spouse (or the estate of the surviving spouse) of the decedent may take into account the DSUE amount in determining the applicable exclusion amount of the surviving spouse when computing the surviving spouse’s gift or estate tax liability.
Making the portability election. An executor electing portability is required to make that election on a timely-filed "complete and properly-prepared" estate tax return Form 706. Every estate electing portability is required to file an estate tax return within nine months of death, unless an extension of time has been granted. This rule applies to all estates electing portability, regardless of the size of the gross estate.
Simplified Method for Small Estates. The executors of estates that would not otherwise be required to file an estate tax return under Code Sec. 6018(a) are not required to report the value of certain property that qualifies for the marital or charitable deduction. If an executor makes use of this special rule, the total value of the gross estate must be estimated based on a determination made with good faith and due diligence regarding the value of all assets includible in the gross estate.
Risks of not filing even for estates under the basic exclusion amount. The surviving spouse inherits money, wins the lottery, or otherwise comes into unexpected wealth. The surviving spouse remarries someone with significant wealth they can use the DSUE for lifetime gifting or their own estate tax before the new spouse’s death. Congress could sharply lower the basic exclusion amount but grandfather the DSUE.
The portability election is a valuable tax benefit that should not be overlooked. Please consider it as part of your overall estate planning and take advantage of the extension of time to make the election. We are available to discuss all of your options.