IRS Extends Portability Election Option Deadline from Two to Five Years

The Internal Revenue Service recently issued a change to the rules regarding portability of a deceased spouse’s unused exclusion (DSUE), expanding the time period from two years to five years. As explained in the recent article “IRS Extends Portability Election” from The National Law Review, portability allows spouses to combine their exemption from estate and gift tax. Here’s how it works.

A surviving spouse may use the unused estate tax exemption of the deceased spouse to lower their tax liability. Let’s say Spouse A dies in 2022, when the estate tax exemption is $12.06 million. If, during Spouse A’s lifetime, they had only used $1 million of their exemption amount, Surviving Spouse B may elect portability to claim $11.06 million DSUE, as long as they file for the exemption within five years of the decedent’s date of death.

Prior to the rule change, the surviving spouse only had two years to claim the DSUE. The due date of an estate tax return is still required to be filed nine months after the decedent’s death or on the last day of the period covered by an extension, if one had been secured.

The IRS had previously extended the deadline to file for portability to two years. However, over time, the taxing agency found itself managing a large number of requests for private letter rulings from estates failing to meet the two year deadline. It was noted many of these requests for portability relief occurred on or before the fifth anniversary of a decedent’s date of death, which led to the current change.

How do I Elect Portability?

To elect portability, the executor (or personal representative) of the estate must file an estate tax return on or before the fifth anniversary of the decedent’s date of death. This estate tax return is a Form 706. The executor must note at the top of Form 706 that it is filed pursuant to Rev. Proc. 2022-32 to elect portability under Sec. 2010(C)(5)(A).

Eligibility to elect portability is not overly burdensome for most people. The decedent must have been a U.S. citizen or resident on the date of their death and the executor must not have been otherwise required to file an estate tax return. This means the decedent was under the estate tax exemption at the time of their death. With the current estate tax exemption now at $12.06 million for an individual, most people will find themselves well under the limit.

This new regulation expands the number of people who will be able to take advantage of the exemption and will help families pass wealth on to the next generation without incurring the federal estate tax. Speak with your estate planning attorney to be sure to elect portability when the first spouse passes, in order not to lose this exemption.

Reference: The National Law Review (Aug. 1, 2022) “IRS Extends Portability Election”

What Does Portability Mean in Estate Planning?
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What Does Portability Mean in Estate Planning?

When one spouse dies, the surviving spouse can choose to make a portability election. This means that any unused federal gift or estate tax exemption can be transferred from the deceased spouse to the surviving spouse. This does not happen automatically, says the recent article “It’s So Important to Elect ‘Portability’ For Your Farm Estate” from Ag Web Farm Journal, but it is worth doing.

Your estate planning attorney will explain how you can take advantage of this opportunity, which must be done at the latest within two years of death. In most cases, no taxes are due, but you must file a form to obtain the exemption.

Before portability was an option, spouses each owned about the same amount of assets, or the amount of assets which would use up each other’s exemptions. For many farm and ranch families, the family’s property is titled one-half to each spouse. Now, however, because of portability, the assets can flow through to the surviving spouse.

At the first spouses’ death, the survivor files for the portability election and then has two exemptions to cover assets.

Here’s an example. A family owns assets jointly and their net worth is about $11 million. They have one son, who also farms. When the husband dies, the wife owns everything. However, she neglects to speak with the family’s estate planning lawyer. No estate taxes are due at this time because of the unlimited marital deduction between the two spouses.

When the wife dies in 2026, when the current federal estate tax exemption is set to drop back to $6 million, their son has to pay $2 million in federal estate taxes. There was $11 million in original assets, but only $6 million for the wife’s exemption. Had she filed for portability when the higher estate tax exemption enacted into law under President Trump, then the $5 million taxable estate would have been reduced by the husband’s exemption by $6 million. No federal estate tax would be due.

Farmers, ranchers and any family business owners need to take into consideration the potential estate taxes in future years. In addition, 17 states still have state estate taxes, and usually the amounts taxed are higher than the federal amount.

An experienced estate planning attorney can work with the family to evaluate their tax liability and see if portability will be sufficient, or if a bypass trust or other tools are needed to protect their legacy.

Reference: Ag Web Farm Journal (April 18, 2022) “It’s So Important to Elect ‘Portability’ For Your Farm Estate”

What Happens to IRAs and 401(k) when Spouse Dies?

For married couples who own large IRA and 401(k) accounts, the question is often whether the couple should consider paying all or a portion of their accounts to a bypass trust to benefit the surviving spouse. This takes the designated portion of the IRA or 401(k) proceeds out of the surviving spouse’s taxable estate and helps with asset distribution, according to the article “Estate Planning for Married Couples’ IRAs And 401(k)s” from Financial Advisor.

In 2013, the portability election became law. Portability allows the surviving spouse to use the unused federal estate tax exemption of the deceased spouse, thereby capturing not one but two estate tax exemptions. Why would a couple need a bypass trust?

The portability election does not remove appreciation in the value of the assets moved from the surviving spouse’s taxable estate. A bypass trust removes all appreciation. An estate planning attorney will review your entire situation to determine the optimal path.

There are also situations when the portability election does not apply. One is if the surviving spouse remarries and then the new spouse predeceases them. With a bypass trust, remarriage does not matter (although estate planning documents do need to be updated).

The portability election also does not apply for federal generation-skipping transfer tax purposes. In other words, the amount that could have passed to an estate and generation-skipping transfer tax-exempt bypass trust, including appreciated value, could now be subject to federal transfer tax in the heir’s estate.

If you use the portability election, those assets are subject to potential lawsuits against the surviving spouse and, if remarriage occurs, to any potential claims of a new spouse. A bypass trust provides better protection from lawsuits and claims.

Using the portability election may result in the first spouse to die losing the option to control where those assets go upon the death of the surviving spouse. A bypass trust provides more control for asset distribution.

The calculations for each situation must be considered, but the bypass trust can help reduce the taxable estate for children, after the surviving spouse has passed. It may also make sense for a portion of the IRA or 401(k) plan proceeds to go to the bypass trust and another portion to the surviving spouse outright. The use of the beneficiary designation may allow for a full or partial disclaimer by the surviving spouse. However, the bypass trust could provide more flexibility than keeping assets in the original accounts.

Reference: Financial Advisor (Jan. 7, 2022) “Estate Planning for Married Couples’ IRAs And 401(k)s”

What Does Portability Mean, and How Do I Use It?

WMUR’s recent article, “Money Matters: Portability and estates,” explains that each taxpayer is typically permitted what is called an applicable exclusion amount. This is the amount of assets that, at your death, you can bequeath to others tax-free for estate tax purposes. Prior to the law change, spouses couldn’t share their exclusions. However, the Tax Cuts and Jobs Act increased this exclusion significantly. In 2019, the exclusion is $11.4 million per person.

The portion that’s not used by the deceased spouse can be transferred to the surviving spouse. The exclusion is indexed for inflation. However, this exemption level is only in effect until 2025. It will then again lower, probably to around half of its current level.

Before this tax law change, the most frequent way to maximize the exclusion was to set up a trust for each spouse—sometimes known an A/B trust. When the first spouse passes away, an amount equal to the exclusion would go to the B trust (also called a credit-shelter bypass trust).

The assets in this trust would be outside the surviving spouse’s estate and, because the exclusion was applied, were not subject to estate taxes. Anything remaining in the estate of the first to die, would be given to the survivor or could be placed in another trust. This trust is often called an A trust (or marital trust). Transfers to spouses aren’t usually subject to estate tax, so assets passing to the A marital trust would have no estate tax liability. At the surviving spouse’s death, his exclusion would be applied to the assets in the A trust. That way, both spouses would get the benefit of their exclusion.  However, this changed with the new tax law. The first spouse to die now uses the exclusion against assets in his estate. Any unused exclusion amounts can then be used by the surviving spouse with their own, at her death.

This would appear to simplify estate planning, for some, the use of two separate trusts will no longer be needed. However, remember these thoughts: (i) the unused applicable exclusion amount from an earlier marriage usually isn’t available, and you can use the amounts only from your last deceased spouse in your estate planning; (ii) these unused exclusion amounts aren’t indexed for inflation, so the property your spouse receives at your death may increase in value in the future, and its value could ultimately be greater than the unused exclusion; and (iii) to use portability, an estate tax return must be filed, so the estate executor must make an election to do so, by filing a return—even if the estate wouldn’t usually be required to do so.

Because of the tax law changes, estate documents drafted before 2010 may not accurately reflect your desire,s because portability and the increase in the exclusion amount can have an effect. Review the changes with your estate planning attorney.

Reference: WMUR (November 21, 2019) “Money Matters: Portability and estates”