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Estates & Trusts

Overlooking Portability Could Cost You

By May 1, 2019No Comments

Do not let the word portability scare you.  It is simply the act of transferring a decedent’s unused gift and estate tax exemption to the surviving spouse.  Since the exemption has doubled under the Tax Cuts and Jobs Act, married couples now have the potential to save millions of dollars in estate tax.

The recently enacted Tax Cuts and Jobs Act included a provision that doubles the federal estate and gift tax exemption; increasing it from $5 million to $10 million, indexed for inflation.  In 2019, this exemption amount is $11.4 million.  However, this change is only temporary and is due to sunset in 2026, returning the exemption back to $5 million (indexed for inflation), unless Congress intervenes.

Thus, in 2019, estates that are worth up to $11.4 million are not subject to tax.  If married, both spouses are allowed this exemption.  So, what happens if your spouse passes away and their portion of the estate is less than $11.4 million?  If nothing is done, the remaining unused exemption is lost.  If, however, an estate tax return is filed timely and the portability election is made, the remaining exemption can be transferred to the surviving spouse to increase the surviving spouse’s available exemption when he/she dies.

Very few couples have estates larger than $22.8 million.  According to the Tax Policy Center, less than 0.1% of individuals, or about 1,700 people who pass away in 2018, will be required to file an estate tax return.  Therefore, many married couples will disregard the thought of filing a return.  However, filing a return to elect portability has the potential to save millions in estate taxes for the surviving spouse.

Example: Bob and Clara are married and reside in California. Bob passes away in January of 2019 when their estate consisted of $16.8 million of community property. An estate tax return is not required. However, Clara must choose whether or not to file a timely estate tax return to elect portability.

  • Scenario 1 – File a return and elect portability: Since Bob died in 2019, his lifetime exemption is $11.4 million. His gross estate is $8.4 million (50% of $16.8 million). He has $3 million of unused exemption that can then be ported to Clara. If Clara dies after the tax reform bill sunsets in 2026 or later, her lifetime exemption is scheduled to be reduced to the original level of $5.7 million plus $3 million ported to her from Bob’s estate. Her new exemption will be $8.7 million.  If Clara dies in 2026 and the her estate is still valued at $8.4 million, her estate will pay no tax.
  • Scenario 2 – No return is filed: If no estate return is filed, Bob’s unused exemption is lost. If Clara dies in 2026 with an estate worth $8.4 million and the lifetime exemption drops to $5.7 million, her estate will have to pay tax on about $2.7 million. That is over $1 million of tax that could have been avoided.

As you can see from the example above, filing a return to electing portability has enormous tax savings potential if the lifetime exclusion is reduced in the future.  It is also beneficial when the surviving spouse expects the value of the estate to grow over time and surpass the exemption amount. Without knowing what the future holds, electing portability can be seen as an insurance policy in case the unforeseeable happens.

In conclusion, portability is the ability to preserve the unused portion of the deceased spouse’s estate tax exemption.  Now, more than ever, portability is a relevant planning tool that allows married couples to take advantage of the increased exemption.  It is also important to note that that any amount carried over to the surviving spouse is lost if they remarry.  If you have questions regarding portability, estate tax planning, or any tax matters, please feel free to contact your L&B professional at (858) 558-9200.

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