Estate Tax Portability represents the single biggest change in the Federal Estate Tax since 1986. Understanding the workings of Portability could have huge financial implications for your heirs – an impact just as significant - if not more so – than your previous estate planning prior to the advent of Portability. Portability was added to the Federal Tax Code in 2011 as a temporary measure that was made permanent in later legislation.
Portability comes into play upon the death of the first spouse to die. It is the ability of a surviving spouse to utilize the unused Federal Estate Tax Exclusion of his or her deceased spouse by filing a timely Federal Estate Tax Return (Form 706) for his or her deceased spouse. Practically speaking, the Personal Representative of the deceased spouse’s estate chooses whether to utilize the Federal Estate Tax exclusion amount for the deceased spouse ($5,450,000 in 2015), or transfer the Deceased Spouse’s Unused Exclusion (DSUE) amount to the surviving spouse.
It is very common for a spouse to die with an estate less that the Federal Estate Tax Exclusion amount, which is $5,450,000, indexed annually for inflation. In these situations, the surviving spouse will not normally file a Federal Estate Tax Return for his or her deceased spouse because there is no Federal Estate Tax payable. However, if there is a possibility that the surviving spouse will have in excess of the Federal Estate Tax Exclusion in the year of his or her death, it is imperative that the surviving spouse file a Federal Estate Tax Return for the deceased spouse by the deadline for filing the return.
The following situation highlights the need to file a Federal Estate Tax return upon the death of a spouse even when the estate is less that the Federal Estate Tax Exclusion amount:
John was killed in a tragic car accident in 2014 when a large truck rear ended him. An Estate was opened in the county Probate Court in the county John lived in at his death. John’s surviving spouse, Linda, had herself appointed Personal Representative by the county Probate Court. John’s Estate for Probate purposes was $400,000 and for Estate Tax Purposes was $610,000 because life insurance on John’s life is includible for Federal Estate Tax purposes.
Linda did not file a Federal Estate Tax return for John by the due date, which is nine months following John’s death. The reason that Linda did not file a Federal Estate Tax return is that there was no Federal Estate payable upon John’s Estate. Subsequent to John’s death, John’s Estate filed a wrongful death lawsuit against the driver of the truck. The case ultimately settled in 2016 for $12,000,000. Of the $12,000,000, $8,900,000 went to Linda as surviving spouse. It may be safely assumed that when Linda dies, her estate will well exceed the Estate Tax Exclusion in the year of her death. She will have John’s estate plus her own estate, which today equals approximately $9,510,000.
If John’s Estate had filed a Federal Estate Tax return, it would have automatically elected for Linda to utilize John’s unused Federal Estate Tax Exclusion up to the amount of portability needed, $4,820,000 ($5,430,000 - $610,000). In addition, Linda will have her own federal estate tax lifetime exclusion in the year of her death.
In the above example, filing a Federal Estate Tax return within nine months of John’s death would have saved the surviving spouse’s heirs at least $820,000.
* Names have been changed to protect confidentiality.