Portability of the Estate Tax Exemption

The American Taxpayer Relief Act of 2012 (ATRA), which was signed into law by President Obama on January 2, 2013, made two important estate and gift tax laws permanent.

First, it set the exemption amount a citizen and noncitizen resident can exempt from federal estate and gift taxes at five million dollars, indexed for inflation.  Currently in 2017, the exemption amount is $5,490,000 for both citizens and noncitizen residents; however, the exemption amount for a noncitizen nonresident remains at sixty thousand dollars ($60,000).  Any amount over the exemption amount is taxed at 40%.

In addition to the increased exemption amount that has been made permanent, a married couple has an unlimited marital deduction that allows them to pass an unlimited amount of assets between spouses; however, all of the assets passing to the surviving spouse would be subject to estate and gift taxes upon his or her passing.  Essentially, the unlimited marital deduction allows a married couple the ability to delay paying estate and gift taxes until the second spouse has passed away.  However, if a surviving spouse is not a citizen, the only way to utilize the unlimited marital deduction is to have any portion passing to the surviving spouse put into a Qualified Domestic Trust (QDOT), discussed below.

Second, it made Portability permanent.  Portability allows a surviving spouse the ability to transfer the deceased spouse’s unused exemption amount (DSUEA) for estate and gifts taxes to a surviving spouse, so long as the Portability election is made on a timely filed federal estate tax return (IRS Form 706).

Please note these laws being “permanent” means that they are not set to sunset (i.e. lapse) and it would take an act of Congress to change or modify them.  It is worth noting that Democratic presidential candidate Sen. Bernie Sanders is calling for what he terms a “responsible” estate tax with a $3.5 million exemption and a 65% top estate tax rate.

Let’s consider the following example for a husband and wife who are citizens:

Husband died in 2016, and Wife is the surviving spouse. Husband and Wife have a total estate of $6.0 million, all community property. When Husband died, his half of the estate (one-half of the community property) was valued at $3.0 million. If Husband leaves his half of the estate outright to Wife, the unlimited marital deduction would allow the entire $3.0 million to pass to Wife free from federal estate taxes, and she would not need to use any of his $5.45 million exemption.  His entire $5.45 million exemption amount would be portable to Wife, so long as she timely files his federal estate tax return (IRS Form 706) to elect Portability (within nine months of his death).

If a timely filed Portability election is made, Wife’s total estate would be $6.0 million; however, she would have Husband’s DSUEA of $5.45 million, as well as her exemption amount of $5.45 million, indexed for inflation, for a total of $10.9 million that she can exempt from estate and gift taxes.  This would allow for additional appreciation in her estate and/or allow for a subsequent reduction in the exemption amount.

If Wife fails to timely file Husband’s federal estate tax return (IRS Form 706) to elect Portability, her total estate would be $6.0 million and she would only have her estate tax exemption amount of $5.45 million, indexed for inflation, to cover what is in her estate when she passes away.  In this case, her estate would pay estate taxes of 40% on any amount that is in excess of her estate tax exemption amount, which could have been avoided if she had timely filed Husband’s federal estate tax return to elect Portability.

The above example is different if the surviving spouse is not a citizen.  Let’s consider the following example for a surviving spouse who is not a citizen:

Husband died in 2016, and Wife, a noncitizen resident, is the surviving spouse. Husband and Wife have a total estate of $6.0 million, all community property. When Husband died, his half of the estate (one-half of the community property) was valued at $3.0 million. If Husband leaves his half of the estate outright to Wife, he would use $3.0 million of his $5.45 million exemption because there is no unlimited marital deduction for property passing to a noncitizen spouse unless the property is put into a Qualified Domestic Trust (QDOT Trust).  The remaining unused $2.45 million of his exemption amount would be portable to Wife, so long as she timely files his federal estate tax return (IRS Form 706) to elect Portability.

If a timely filed Portability election is made, Wife’s total estate would be $6.0 million; however, she would have Husband’s DSUEA of $2.45 million, as well as her exemption amount of $5.45 million, indexed for inflation, for a total of $7.9 million that she can exempt from estate and gift taxes.

On the other hand, if at the first passing, Husband leaves his half of the estate in a QDOT Trust to Wife, he would use none of his $5.45 million exemption because the unlimited marital deduction would apply, and his entire exemption amount would be portable to Wife, so long as she timely files his federal estate tax return (IRS Form 706) to elect Portability.

The laws concerning estate and gift taxes are complex and have changed dramatically over the past five years, especially with respect to Portability.  If you have not spoken to one of the attorneys in our office within the past five (5) years, or if you have any questions regarding your estate plan, we recommend calling our office to schedule an appointment with one of our attorneys to review and update your estate planning documents.

This article was co-authored by Associate Attorney Philip S. Sousa and Mark S. Drobny. To contact Philip, e-mail him at pss@drobnylaw.com or call (916) 419-2100, ext 237.  To contact Mark S. Drobny, email him at msd@drobnylaw.com or call (916) 419-2100, ext. 236.

 

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