Portability of Estate Tax Exemption: How to Maximize Your Family’s WealthOctober 9, 2024

Estate tax planning is crucial for high-net-worth families. One of the key strategies to simplify this process and potentially save millions is through the portability of estate tax exemption. This provision allows spouses to transfer any unused portion of their estate tax exemption to each other, making sure that more of their family wealth is protected from federal taxes.

In this post, we will explain what the estate tax exemption is, how portability works, and how to leverage it in estate planning. We’ll also compare portability with other strategies like bypass trusts to help you choose the best approach for your situation.

Understanding Portability of Estate Tax Exemption

What is the Estate Tax Exemption?

The estate tax exemption is the amount of wealth you can pass to your heirs tax-free when you die. As of 2024, the federal estate tax exemption is $12.92 million per person. This means that if your estate’s value is under this threshold, your heirs won’t have to pay any federal estate taxes.

Estate taxes in the United States have a long history, dating back to 1916. The exemption has changed many times due to tax reform laws, most notably through the Tax Cuts and Jobs Act of 2017, which significantly increased the exemption amount. However, this law is set to expire in 2026, reducing the exemption back to around $6 million unless new legislation is passed.

What is Portability in Estate Tax?

Portability refers to the ability of a surviving spouse to inherit the unused estate tax exemption of their deceased spouse. This effectively doubles the amount a couple can pass to their heirs tax-free, without having to set up complicated estate planning structures.

Portability was first introduced in 2010 as part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act. It allows couples to maximize their estate tax exemption without needing to create separate trusts or structures.

How Portability Works in Estate Planning

Here’s how portability works in practice:

• If Spouse A dies and doesn’t use their full estate tax exemption, Spouse B can claim the unused portion. This is known as the Deceased Spousal Unused Exclusion Amount (DSUE).
• To benefit from this, Spouse B must file IRS Form 706 within nine months of Spouse A’s death, which officially transfers the unused exemption.

For example, let’s say Spouse A has an estate worth $6 million. This leaves $6.92 million of their estate tax exemption unused. By filing the necessary paperwork, Spouse B can add that $6.92 million to their own exemption, potentially saving millions in future estate taxes.

Eligibility and Requirements

Not everyone automatically qualifies for portability. Here are the key requirements:

• U.S. Citizenship: Only U.S. citizens or legal residents can take advantage of portability.
• Form 706 Deadline: The surviving spouse must file Form 706 within nine months of the spouse’s death. An extension may be granted, but failing to file on time could result in losing the portability benefit.

Additionally, there are some common pitfalls, such as not filing Form 706 when the estate is below the exemption threshold. Even if you don’t owe estate taxes immediately, it’s important to file this form to preserve the portability benefit for future use.

Maximizing the Benefits of Portability

Key Benefits of Estate Tax Portability

For high-net-worth families, estate tax portability offers several advantages:

1. Increased Exemption: Portability allows spouses to effectively double their estate tax exemption, potentially saving millions in taxes.
2. Simplified Planning: Families can avoid the complexities of creating bypass trusts or other complicated legal structures.
3. Tax-Efficient Wealth Transfer: Portability allows for a smooth and tax-efficient transfer of wealth between generations.
4. Flexibility: Portability provides more flexibility, especially for couples who may not have established detailed estate plans early on.

Limitations of Portability

While portability offers significant advantages, it does have some limitations:

• No Adjustment for Inflation: The unused exemption (DSUE) is not adjusted for inflation, meaning its value can erode over time.
• Does Not Cover Generation-Skipping Transfer Taxes (GSTT): Portability applies only to federal estate taxes, not GSTT, which is important if you’re planning to leave wealth to grandchildren.
• Proactive Planning Required: Even if the estate is below the exemption threshold, filing Form 706 is necessary to benefit from portability later on.

Portability vs. Bypass Trusts: Which is Better?

When it comes to estate planning, many families wonder whether portability or bypass trusts are the better option. Each has its pros and cons.

• Portability is straightforward and easy to implement, but it doesn’t offer the same level of asset control.
• Bypass Trusts allow for more control over how assets are distributed and provide protection from creditors and remarriage. However, they can be more complex and costly to set up.

For many families, portability will suffice, but if your estate is particularly large or if you’re concerned about protecting assets from creditors, a bypass trust may be a better option.

Portability in Different Tax Scenarios

Portability can be beneficial for both large and small estates, but it’s important to consider state-level estate taxes, which are separate from federal taxes and don’t always allow for portability. Additionally, with the potential sunset of current estate tax laws in 2026, families should be proactive in their planning to avoid any surprises.

FAQs About Portability of Estate Tax Exemption

How Does Portability Affect My Estate Planning?

Portability can significantly enhance your estate planning by doubling the tax-free amount your family can inherit. It simplifies the process and can save your heirs millions of dollars in taxes, but proactive steps, like filing IRS Form 706, are crucial to fully benefit.

What Happens If I Don’t File Form 706?

If you miss the deadline to file Form 706, you lose the ability to transfer the unused estate tax exemption, which could result in substantial tax liabilities. Extensions are sometimes granted, but this is not guaranteed.

Does Portability Apply to All Estates?

Portability is generally available for most estates but doesn’t cover every scenario. For instance, it does not apply to generation-skipping transfer taxes or certain types of non-U.S. citizens without estate tax treaties.

Please contact Lynn Conover at lconover@curchin.com with any additional questions or feedback regarding Estate Planning.