President Barack Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act (TRUIRJCA) into law on December 17, 2010. Significant modifications were made to the rules governing federal estate taxes, gift taxes, and generation-skipping transfer taxes as part of this law, and portability of the estate tax exemption was introduced for the first time.
The Definition of Portability
Portability is only available to married couples. The amount of the estate tax exemption that was not used for the deceased spouse's estate can be transferred to the surviving spouse if the first spouse dies and the value of their estate doesn't use up all the exemption.
The surviving spouse can use the deceased spouse's unused estate tax exemption plus their own exemption when the surviving spouse later dies.
This is a federal exemption. Only Hawaii and Maryland offer portability of its state estate tax exemption at the state level as of 2020.
The Federal Estate Tax Exemption
The federal estate tax exemption is indexed for inflation, so it increases periodically, usually yearly. It's $11.58 million for deaths occurring in 2020, up from $11.4 million in 2019. It's basically $11 million plus inflation adjustments.
Exemptions are subtracted from the value of an estate, and only the balance is subject to the estate tax. Very few estates have to pay this tax as a result.
The History of Portability
The TRUIRJCA introduced the concept of "portability" of the federal estate tax exemption between married couples for the 2011 and 2012 tax years. Then President Obama signed the American Taxpayer Relief Act (ATRA) into law on January 2, 2013, and ATRA made this portability feature of the estate tax permanent as of 2013.
Portability should remain a permanent part of federal estate tax law going forward unless Congress takes step to repeal this provision. Thanks to ATRA, it no longer has to be renewed to remain in effect.
The Tax Cuts and Jobs Act (TCJA) effectively doubled the federal estate tax exemption in 2018. It was $5.49 million in 2017. But the TCJA expires at the end of 2025, so it's possible that the exemption could plummet to roughly half its 2020 value at that time unless Congress takes steps to renew the legislation.
Examples of Portability
The option of portability can make a significant difference when it comes to taxation of an estate.
The Estate Tax Without Portability
Assume Bob and Sue are married and tall their assets are jointly titled. Their net worth is $18 million. Bob dies first in 2020 and the federal estate tax exemption is $11.58. Portability of the estate tax exemption between spouses is not in effect.
His estate won't need to use any of his $11.58 estate tax exemption when Bob dies because all the assets are jointly titled. The unlimited marital deduction allows Bob's share of the joint assets to be automatically transferred to Sue by right of survivorship without incurring any federal estate taxes.
The federal estate tax exemption is still $11.58 million when Sue dies. The estate tax rate is 40%, and Sue's estate is still worth $18 million.
Bob's $11.58 million estate tax exemption went unused and Sue couldn't claim it without portability, so Sue can only pass on $11.58 million to her heirs free from federal estate taxes when she dies. Sue's estate will owe about $1,064,000 in estate taxes after her death:
- $18,000,000 estate less the $11.58 million exemption = $6.42 million taxable estate
- $6.42 million taxable estate x 40% estate tax rate = $2.568 million in taxes due
The Estate Tax With Portability
Let's assume the same scenario: Bob and Sue are married and have all of their assets jointly titled. Their net worth is $18 million. Bob dies first and the federal estate tax exemption is $11.58 million on the date of Bob's death. Portability of the estate tax exemption between spouses is in effect, so when Sue dies:
- $18 million estate less $23.16 million in two estate tax exemptions = $0 taxable estate
Bob's estate won't have to use any of his estate tax exemption because all their assets are jointly titled and they pass directly to Sue by right of survivorship. Assume that the federal estate tax exemption is still $11.58 million at the time of Sue's later death. The estate tax rate is still 40%, and Sue's estate is still worth $18 million.
Using the concept of portability between spouses, Bob's unused $11.58 million estate tax exemption would be added to Sue's $11.58 million exemption, which gives Sue a $23.16 million exemption when the two are added together.
Sue has "inherited" Bob's unused estate tax exemption and she can pass on $18 million free from federal estate taxes at the time of her death. Sue's estate will not owe any federal estate taxes at all.
Portability of the estate tax exemption will save Bob and Sue's heirs about $2.568 million in estate taxes.
Sue won't automatically "inherit" Bob's unused exemption. She must file IRS Form 706, the United States Estate and Generation-Skipping Transfer tax return, at the time of Bob's death to make an election to add his unused exemption to her exemption.