How to Elect Portability of the Federal Estate Tax Exemption
Making Use of a Deceased Spouse's Unused Estate Tax Exemption
On December 17, 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act ("TRUIRJCA" for short) was signed into law by President Obama. Aside from increasing the estate tax, gift tax, and generation-skipping transfer tax exemptions to $5,000,000 for 2011 and $5,120,000 for 2012, this law introduced the concept of “portability” of the federal estate tax exemption between married couples. Also, on January 2, 2013, the American Taxpayer Relief Act ("ATRA" for short) was signed into law, which has made portability a permanent option for married couples.
What Does Portability of the Estate Tax Exemption Mean?
Portability of the estate tax exemption means that if one spouse dies and does not make full use of his or her $5,000,000 (in 2011, or $5,120,000 in 2012, $5,250,000 in 2013, $5,340,000 in 2014, and $5,430,000 in 2015) federal estate tax exemption, then the surviving spouse can make an election to pick up the unused exemption and add it to the surviving spouse’s own exemption.
What a great concept, right? Well, keep in mind that historically the “AB Trust” system was designed to do what the portability election does. Under an AB Trust estate plan, when the first spouse dies, his or her or estate will be divided into two separate trusts, one that is equal to the federal estate tax exemption (this is the “B Trust”), and one that holds the amount that exceeds the exemption (this is the “A Trust”). (Note that if the value of the deceased spouse’s estate does not exceed the estate tax exemption, then only the “B Trust” will need to be created and funded.) By dividing the deceased spouse’s estate into two portions, an AB Trust plan allows the B Trust to pass estate-tax free to the heirs after the surviving spouse dies.
And since the surviving spouse will have their estate tax exemption that can be applied to the value of their estate, an AB Trust plan will allow a married couple to pass on two times the federal estate tax exemption free from federal estate taxes. (Note: In some states that collect a separate state estate tax, "ABC Trust" planning is necessary instead of AB Trust planning.)
But now, with the introduction of portability of the estate tax exemption, married couples do not have to use AB Trust planning to take advantage of both spouses’ estate tax exemptions.
For example, if Bob and Sally are married and Bob dies in 2011 and only uses $3,000,000 of his $5,000,000 federal estate tax exemption, then Sally can elect to pick up Bob's unused $2,000,000 exemption and add it to her estate tax exemption. Assuming that Sally has not used any of her estate tax exemption for lifetime gifts and makes the portability election, then Sally will have a $7,250,000 exemption in 2013 (Bob's unused $2,000,000 exemption plus Sally's $5,250,000 exemption = $7,250,000 exemption).
How to Make a Proper Portability Election
So how does Sally go about making the election to use Bob's unused estate tax exemption? For a surviving spouse to properly make the election to use the deceased spouse’s unused estate tax exemption, the surviving spouse must timely file IRS Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. Form 706 is due on or before nine months after the deceased spouse’s date of death; however, an automatic six-month extension can be requested by filing an IRS Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes, on or before the due date for Form 706.
Note: On February 17, 2012, the IRS released Notice 2012-21, which provides that for certain estates, the portability election can be made within 15 months after the date of death even if the surviving spouse failed to timely file a Form 4768.
What Is the Future of Portability of the Estate Tax Exemption?
While the provisions of TRUIRJCA officially expired on December 31, 2012, the provisions of ATRA have made portability a permanent option for married couples. Of course, anything that Washington makes "permanent" is permanent until a decision is made that it should be changed.