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Portability of Unused Estate Tax Exclusion

Article Highlights:

  • Estate Tax

  • Lifetime Exemption

  • Surviving Spouse

  • Portability Election

  • Financial Drawback

  • Election Considerations

  • Portability Extension

When an individual dies, the value of that individual’s estate is subject to estate taxation, which is currently 40% of the individual’s taxable estate. However, there is a lifetime exclusion (exemption) to the estate tax, which for 2022 is $12.06 million. The lifetime exclusion can also be used to offset taxable gifts – those that exceed the annual gift tax exclusion. This means for someone dying in 2022 who hasn’t previously dipped into their lifetime exclusion to offset gift tax, the first $12.06 million of the individual’s estate is exempt from estate tax and passes tax-free to the individual’s beneficiaries. This lifetime exclusion amount is annually adjusted for inflation and is also subject to the whims of Congress. The table below illustrates the exclusion amounts for recent years.

Lifetime Estate Tax Exclusion

Year

Amount

2019

$11.40 Million

2020

$11.58 Million

2021

$11.70 Million

2022

$12.06 Million

In the case of married taxpayers, each spouse has a separate lifetime exclusion equal to the $12.06 million (for 2022).

Example – Looking at a simplistic situation, let’s say a married couple, Ben and Sylvia, have a joint estate valued at $15 million in 2020 when Ben passed away. He had not made any taxable gifts during his lifetime. Ben’s estate subject to estate tax was $7.5 million (half of the $15 million). In 2020, the estate and gift tax exemption amount was $11.58 million; thus Ben’s estate subject to tax is zero ($7.5 million less $11.58 million). Sylvia is Ben’s sole beneficiary, so she inherits his $7.5 million estate, which combined with her $7.5 million brings her estate total to $15 million (and for this example doesn’t increase or decrease over the coming years). Sylvia passes away in 2022 when the estate tax exemption is $12.06 million. Sylvia’s taxable estate is $2.94 million ($15 million less $12.06 million), resulting in an estate tax of $1,121,800 (based on the estate tax rate schedule which is $345,800 on the first $1 million and 40% of the balance).

However, married taxpayers have a special benefit that allows a surviving spouse to make what is called a portability election. The portability election essentially allows the surviving spouse to add the deceased spouse’s unused estate tax exclusion to their own. During the surviving spouse’s remaining lifetime, the exclusion can be used to offset taxable gifts and whatever isn’t used that way is available to reduce the surviving spouse’s estate tax upon his or her death.

Example – Using the previous example, when Ben passed in 2020, the estate tax exclusion was $11.58 million, and his estate was $7.5 million. Thus, his unused estate tax exclusion was $4.08 million ($11.58 million – $7.5 million). Sylvia made no taxable gifts since Ben’s death. Had the portability election been made, which required filing an estate tax return for Ben’s estate, Sylvia’s estate tax exclusion in 2022 would have been $16.14 million ($4.08 million + $12.06 million). Thus, none of Sylvia’s $15 million estate would have been taxed since the exclusion of $16.14 million exceeded the value of her estate. The resulting tax savings is $1,121,800.

However, there is a significant financial drawback related to making the portability election. Even though filing an estate tax return for the first spouse to die might not be required because the estate’s value is less than the exclusion amount, to make the portability election, filing an estate tax return, IRS Form 706, is required. An estate tax return is lengthy, complicated, and costly to have prepared.

This, tied to the fact that the preponderance of surviving spouses’ estates will be less than the lifetime exclusion and they will probably see no benefit from electing carryover of their deceased spouse’s unused exclusion, most surviving spouses make the decision not to go to the expense of filing the Form 706.

However, there are factors that must be carefully considered before making that the decision.

  1. As discussed in the prior examples the surviving spouse will have inherited the deceased spouse’s estate assets, thus increasing the value of the surviving spouse’s estate.

  2. Inflation can cause the value of the surviving spouse’s estate to substantially increase depending upon the number of years the surviving spouse lives after the death of the deceased spouse, the type of assets inherited and how they are invested, the surviving spouse’s expenses, etc.

  3. Then there is the potential that Congress could actually reduce the lifetime exclusion. There has been proposed legislation in the past that would have reduced the exemption to as little as $3.5 million.

  4. There is the possibility of the surviving spouse receiving an inheritance from a relative or friend.

  5. The possibility of hitting the lotto big.

The list goes on, and all possibilities must be considered before making the decision to incur the expense of making the election or not.

Should the decision be made not to file the portability election, the deceased spouse’s estate executor can expect the tax preparer to request a signed statement that preparation of a Form 706 for the deceased spouse’s estate and electing to claim the deceased spouse’s unused exclusion are declined, in case that decision might be questioned in the future by the surviving spouse’s beneficiaries.

Extension to File for Portability – The IRS recently issued Revenue Procedure 2022-32 that provides a liberal extension of time for filing Form 706 exclusively for the purpose of making the portability election, does not require a user fee, and should be used in lieu of the letter ruling process that was previously in effect. Under this simplified procedure, the portability election may be made if a complete and properly prepared Form 706 is filed on or before the fifth anniversary of the decedent's death.

The simplified method is only available to estates that are not required to file an estate tax return based on the value of the gross estate decedent’s date of death must be after Dec. 31, 2010, and the decedent must have been a U.S. citizen or resident on their date of death and have a surviving spouse.

All of this can be quite complex, and you are strongly urged to contact this office for assistance.

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