1 Gift and Estate Tax Planning Insights The Perils and Prospects of Portability Jeffrey M. Cheyne, Esq. With the passage of federal tax relief laws in recent years, the porting of unused federal estate tax exemptions has proven to be an important federal estate tax saving strategy, especially among individuals who have accumulated substantial wealth. This discussion considers the changing legal landscape, requirements for federal Portability elections, the status of Portability under state law, complications with Portability . This discussion also presents some helpful practitioner guidance and tips. Introduction tions would return to 2001 levels. However, Congress extended some of the key provisions of EGTRRA for Generations of attorneys and accountants have two years with the enactment of the Tax Relief, utilized estate planning tools like the credit shel- Unemployment Insurance Reauthorization, and Job ter trust (also often called the A/B, family, or Creation Act of 2010 ( 2010 Tax Relief Act ).)
2 The bypass trust) to minimize potential state and 2010 Tax Relief Act raised the federal estate tax federal estate taxes for the families that they work exclusion to $5,000,0001 and established a top mar- with. ginal federal estate tax rate of 35 percent. Recent changes to the federal income tax rates, The 2010 Tax Relief Act also included a provi- estate tax rate and the federal exclusion amount sion that allowed the designated executor, which in have caused a ground shift beneath some of these many cases is the surviving spouse, to elect to trans- commonly used estate planning and tax strategies. fer the unused federal exemption of the deceased As a result of changes to the federal estate and spouse and add it to his or her own basic exclusion income tax structures since 2010, and especially amount (BEA). This concept is called portabil- in light of the introduction of the option to port ity.
3 However, this provision was set to expire on unused federal estate tax exclusion of the deceased December 31, 2012. spouse to the surviving married spouse, clients Then the American Taxpayer Relief Act of 2012. should be invited to review their current estate (ATRA) was enacted on January 2, 2013, and the plans to reevaluate the tax implications of their Portability election for the deceased spouse's unused planned asset transfers. exclusion (DSUE)2 was extended and became per- manent. The BEA continues to be indexed for infla- tion and the federal estate tax rate was increased to Portability under Federal Law 40 percent. On June 7, 2001, George W. Bush signed the As a result of inflation adjustments, the 2013. Economic Growth and Tax Relief Reconciliation Act BEA was increased to $5,250,000, and for 2014 the of 2001 (EGTRRA), ushering in dramatic changes BEA has increased to $5,340,000. With the continu- to the Tax Code.
4 These changes included ing increases in the BEA more and more estates will increasing the federal estate tax exclusion threshold be exempt from any federal estate tax, and taxable from $675,000 to $3,500,000 over an eight-year estates will pay less federal estate tax. period. Then, for one year (2010), the estate tax As an example, let's assume that the first spouse was repealed. died in 2014 with all of his or her assets owned in EGTRRA was scheduled to expire on January 1, joint title with the surviving spouse. Assuming fur- 2011, at which point the rules, rates, and exemp- ther that the deceased spouse made no gifts during INSIGHTS AUTUMN 2014 23. ing spouse and the other heirs of the estate are not likely to spend the time or money to prepare a Federal Form 706 to make the DSUE election. From their perspective: If the filing of a federal estate tax return and a state estate tax return is not required, why waste the money?
5 But such a decision may be shortsighted. If the surviving spouse won the lottery, or was awarded a significant personal injury judgment, or experienced a significant wealth enhancement event, then the heirs may later regret that a porta- bility election was not Generally, there is no downside to making the Portability election even for spouses with estates valued substantially less than the applicable estate exclusion amount. his or her lifetime that required the filing of a federal If the first spouse to die is a resident of a state with Form 709 gift tax return and as a result had a DSUE a state estate tax, such as Oregon or Washington, and of $5,340,000. The executor of the deceased spouse he or she dies as a resident of that state with an estate would then be allowed to elect to increase the sur- valued in excess of the state exemption amount but viving spouse's total federal applicable exclusion less than his or her federal BEA, then it will probably amount up to $10,680,000 by electing to port the be necessary to file a state estate tax return, but no DSUE of the first spouse and add it to the surviving federal estate tax return will be required.
6 Spouse's BEA. In this case, the cost of preparing and filing a One of the ramifications from Portability is that Federal Form 706 under these circumstances may be estate planners must now compare the income tax minimal, as many state estate tax forms require the savings resulting from the tax basis adjustment preparation of the Federal Form 706 asset and liabil- equal to the fair market value as of the date of ity schedules to attach to the state return anyway. death3 when the second spouse dies with the estate tax savings created by various planning options such Since most of the work to complete the federal as the traditional credit shelter trust. return has to be finished in order to prepare the state return, then it would make sense to file the A DSUE election made under these circumstanc- federal return and make the Portability election just es may be worth as much as $2,136,000 ($5,340,000.)
7 In case the surviving spouse has the good fortune of times 40 percent) in federal estate tax savings to accumulating a larger estate. The heirs will appreci- those who receive assets from the surviving spouse ate that a DSUE election was made when the first either during the surviving spouse's lifetime or at his spouse died since the additional federal estate taxes or her death. are easily avoided. Furthermore, if there is a significant income tax basis increase when the surviving spouse dies, there When the heirs learn that the surviving spouse could be substantial income tax savings when the could have significantly reduced or avoided the fed- property is subsequently sold. eral estate tax with a timely filed Portability election after the death of the first spouse, they may ques- tion why the professionals who advised the surviv- Do Similar Portability Elections Exist ing spouse and the executor after the first spouse died did not recommend that a DSUE election be Under State Law?
8 Made. This is especially true if a state return has There are no Portability provisions similar to federal been prepared and filed. law in all but two states. Hawaii allows the surviving spouse to port the unused exemption for decedents who died after January 25, 2012, and, at the time of What Are the Requirements to Make this writing, Delaware is considering adding porta- bility provisions to its estate tax regulations. a Federal Portability Election? In order to make a federal Portability election, a For a married couple living in a state with no Form 706 federal estate tax return must be filed in state estate tax or in a state with a state estate tax a timely manner. The Portability election provisions but the combined value of the couples' estate is on the Form 706 need to be completed even though less than the state exclusion amount,4 the surviv- 24 INSIGHTS AUTUMN 2014 no federal estate tax is Once the election is 706 federal estate tax return and making a portabil- made, it is irrevocable.
9 Ity election would be appropriate for the surviving The initial filing deadline is nine months after spouse. the date of death. If a timely extension application Revenue Procedure 2014-18 does not apply to is filed within nine months following the date of taxpayers that filed an estate tax return in a timely death, the time for filing a Form 706 federal estate manner and either elected Portability or opted out. tax return and making the Portability election can Taxpayers that are not eligible for relief under this be automatically extended for an additional six revenue procedure may request an extension of months. time to make the Portability election by requesting The surviving spouse, unless he or she is appoint- a letter ruling under the provisions of Regulation ed by a probate court as the executor, does not have Section the exclusive right to make the Portability election. This can be a problem if the executor named in the Complications with Portability will and appointed by the probate court is a descen- Portability is complicated.
10 Here are some examples: dent of the deceased spouse, but not a descendant of the surviving spouse. Due to animosity or other 1. Portability can simplify the planning pro- issues, the executor may not be willing to make the cess, reduce up-front costs, and may reduce Portability election. or eliminate federal estate taxes due upon the death of each spouse. A Portability elec- tion can be useful when a significant part of Recent Development: Service the decedent's estate consists of assets that Expands Estate Tax Portability are hard to transfer to a credit shelter trust, such as annuities, retirement plan accounts Options For Nonfilers and the personal residence. Prior to January 27, 2014, the only option to obtain However, Portability does not provide permission to make a late Portability election was families with the opportunity to utilize to request a private letter ruling under Treasury some of the divorce protection, asset pro- Regulation Sections and and tection, and generation skipping planning pay a significant user-fee ($2,000 to $10,000).