Historically in America, each citizen and permanent resident had a certain amount of assets that they could pass on to their heirs free of an estate tax. This amount is known as the federal estate tax exemption. In 2010, the government passed a law allowing for federal estate tax portability. Federal estate tax portability enables the unused estate tax exemption of the first spouse to die to be transferred to the surviving spouse.
Prior to 2010, the federal estate tax exemption was “Use it or lose it”. Accordingly, if one spouse left everything outright to a surviving spouse, they effectively had only one exemption. So imagine this common example. A husband and wife have $7M and the exemption amount is $5M. One spouse dies leaving all to the surviving spouse, upon the death of the second spouse everything goes to their children. If there is portability, the children do not have to worry about a federal estate tax. Without portability, there is a tax of approximately 40% on the amount over the $5M exemption – an $800,000 tax!
This estate tax could be minimized with a good estate plan.
Problems With Federal Estate Tax Portability
The biggest problem with portability is that it is not automatic. In order to transfer a Deceased Spouse’s Unused Exemption (DSUE) to a surviving spouse, the executor must timely file a federal estate tax Form 706. Originally, the IRS required the executor to file a return within 9 months from date of death. (Although the IRS always grants an automatic 6 month extension.) Additionally, the executor must be sure to elect portability on the return.
With the estate tax exemption escalating from $5M per person in 2010 to $11.7M per person in 2021, many people did not feel a reason to file for portability. However, now there are multiple proposals floating around Congress to reduce the federal estate tax exemption to $5M again or even down to $3.5M. Moreover, even if Congress does nothing, the current federal estate tax exemption is supposed to sunset in 2026. If the law sunsets, each person will only have an estate tax exemption of approximately $6 million since it is indexed for inflation. If your spouse has died and you haven’t elected to file for the federal estate tax portability, your heirs could be in for a nasty tax surprise.
It May Not Be Too Late to File for Portability
Originally, the timeframe for filing for portability was quite strict. However, under Treasury Regulation §301.9100-3, the IRS may grant relief. The taxpayer must establish to the satisfaction of the Commissioner that the taxpayer acted reasonably and in good faith and that the grant of relief will not prejudice the interests of the government. This rule meant that taxpayers were constantly reaching out to IRS for guidance as to whether an extension was in good faith. Accordingly, the IRS needed a simpler rule. Pursuant to Revenue Procedure 2017-34, if the estate was not otherwise required to file a Form 706 estate tax return, taxpayers now generally have a two year window in which to file for portability. It should be noted that a taxpayer may still file after two years if you can still establish that you were acting reasonably and in good faith.
[Edit: Note new 5 year portability rule: https://pollockfirm.com/5-year-estate-tax-portability-election/]
Should You File for Portability?
This all begs the question – should you file for federal estate tax portability? While it costs time and money to prepare an estate tax return, the more assets you have, the more we recommend a return be filed to minimize a potential estate tax. If a person passes away, there is a 40% tax to the extent the person’s assets are over the federal estate tax exemption. Accordingly, we strongly believe that you should file for portability if any of the following is true:
- if the surviving spouse’s estate is likely to exceed $3M at any time;
- if you have made significant gifts; or
- if you may inherit money from a relative.
However, as always, please consult an experienced attorney for advice specific to your situation. If you have any questions regarding federal estate tax portability or probate matters, please reach out to Elizabeth C. Ketterson, Esq. Elizabeth is the head of our firm’s estate administration department.