Posted by Mike Kelly, CPA
George Steinbrenner, the former Yankees owner, died in 2010, during a period when the estate tax was repealed. The rest of us will likely never see that again as the estate tax appears to be around for the foreseeable future. For 2016, a tax up to 40% is imposed on taxable estates exceeding $5,450,000. This can be a crippling tax, however there are ways to utilize creative planning strategies to reduce the impact of the tax and we will focus on one of them in this article. That strategy is called portability.
Congress has granted every taxpayer a lifetime exemption that shields a portion of their assets from the estate tax. Therefore, any taxpayer whose assets fall under this threshold will not have to pay any federal estate taxes upon death.
Before portability was introduced in 2011, a taxpayer would either have to use or lose their exemption. This could present problems for married couples with combined wealth greater than the exemption because a surviving spouse could potentially own all of the first spouse’s assets at death, but none of that spouse’s exemption. This could expose the second spouse to the estate tax. Portability fixed this issue and gave the surviving spouse the opportunity to utilize the unused portion of the first spouse’s exemption (DSUE). The following example should help illustrate the benefits of portability.
Assumptions: A and B were married and both died in 2015, when the lifetime exemption is $5,450,000. Both A and B had $6,000,000 of assets titled in each of their names, for a combined value of $12,000,000. A died first, leaving everything to B. The asset values did not appreciate and portability was elected for A. Below is an analysis of the taxable estates of A and B at each of their deaths.
Notice that A did not need to use any of the exemption at death because of the unlimited marital deduction that is available for spouses. However, B was able to utilize A’s unused exemption since the remaining gross estate of $12,000,000 exceeded B’s exemption of $ 5,450,000. This would result in massive tax savings with a maximum tax rate of 40%.
Below are some important facts about portability:
How to make the election – Caution – portability is not automatic. A timely Form 706 must be filed for the estate of the spouse who died first in order for the election to become effective. This is true even if the first spouse is not otherwise required to file an estate tax return.
Remarriage – If the surviving spouse remarries, he still keeps the DSUE from his original spouse. However, if his new spouse passes away, he loses the DSUE from his original spouse and gains the DSUE from his new one. If instead, the surviving spouse remarries and passes away first, his new spouse cannot receive transferred DSUE from the first marriage.
Step-up in Basis – When a person passes away, all of the assets in his estate receive a “step-up in basis.” This means the cost basis is adjusted to the fair market value of the asset at the date of death. If the beneficiary sells the asset in the future, the increased basis will help offset any potential gain on the sale. Married couples who rely strictly on portability will receive two potential basis step-ups – one after the first spouse passes away and another one after the death of the second. Taxpayers who are involved with other sophisticated tax planning strategies that use trusts won’t receive the step-up after the second spouse’s death.
State Taxes – Most states do not currently allow portability and many have smaller exemption amounts than the federal amount. An analysis may need to be performed if it would be more beneficial to use a combination of trusts and the DSUE to ensure the state exemption is utilized.
The estate tax can pack a heavy punch. Portability is a convenient, cost-effective tool to use for smaller estates. But it may not always be the best choice. Talk with our estate and trust team so we can help ensure your future beneficiaries do not lose some of their inheritance to the government due to inefficient planning.