Portability and Estate Planning

This blog entry appeared in the West Virginia Lawyer, January-March 2015 Edition.

I. Genesis of Portability

Portability was statutorily created in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (herein “2010 Act”) and made permanent by the American Taxpayer Relief Act of 2012 (herein “ATRA”). Along with creating portability, these two Acts changed the dynamics of estate planning for the vast majority of taxpayers. The 2010 Act also increased the exemption amount for estate, gift and generation- skipping transfer tax purposes to $5,000,000 and indexed the amount for inflation.

The increased exclusion amount eliminates estate tax concerns for the majority of taxpayers. In 2015, only decedents whose gross estate exceeds $5,430,000 must file a United States Estate (and Generation-Skipping Transfer) Tax Return (herein “Form 706”).

II. What Is Portability?

Portability refers to the transferability of the applicable exclusion amount to the surviving spouse. Prior to the 2010 Act, this was not an option. The traditional rule regarding one’s applicable exclusion amount was “use it or lose it.”  Portability, however, allows a surviving spouse to use the applicable exclusion amount that remains unused at the death of his or her predeceased spouse, in addition to his or her own applicable exclusion amount.

Example:Norman dies in 2015, and a total of $2,000,000 of assets pass under his estate plan to a non-marital trust for his wife, Rosie. Norman’s executor elects to have his $3,430,000 of unused exclusion amount transferred to Rosie. If Rosie took no further action and died in 2015, she would have a total of $8,860,000 of applicable exclusion amount that could shelter property from estate tax.

The intention of portability was to simplify estate planning by eliminating the need for a married couple to create a credit shelter trust at the first death in order to utilize the applicable exclusion amount. It also allows couples to avoid retitling assets, which was sometimes necessary in credit shelter trust planning in order to maximize use of the applicable exclusion amount upon the first death. In the past, couples considered retitling assets between themselves to balance ownership and to make sure whichever spouse passed first, the applicable exclusion amount could be used. Thus, joint ownership of accounts were typically disfavored.

Portability has created the opportunity to move away from the traditional estate planning techniques of the past. Since the enactment of the unlimited marital deduction in 1981, estate planners have built estate plans around the creation of two shares: a credit shelter, or non-marital share, to use the applicable exclusion amount and a marital share to defer any tax using the marital deduction. Now, with portability, the decedent’s failure to use a credit shelter type trust or similar taxable disposition does not mean that his or her applicable exclusion amount is wasted.

Estate planners are now challenged with what to do with portability. Because of the larger exclusion amount and the option of portability, planners are faced with a number of difficult issues.

Should our clients transfer tax plan at all?

If transfer tax planning is advisable, what is the best way to utilize the applicable exclusion amount (through traditional planning, reliance on portability, or some combination of the two)?

What is the best way to implement generation-skipping transfer tax planning?

With the increased income tax rates, what are the income tax ramifications of the various options, particularly how they impact basis?

III. Provisions and Scope of Portability

Section 2010 of the Internal Revenue Code of 1986, as amended, (herein “IRC”), creates portability by introducing the concept of “deceased spousal unused exclusion amount” (herein “DSUE amount”). Section 2010(c)(2) defines the applicable exclusion amount as “the sum of (A) the basic exclusion amount, and (B) in the case of a surviving spouse, the deceased spousal unused exclusion amount.”  Section 2010(c)(4) defines the deceased spousal unused exclusion amount as the lesser of (i) the basic exclusion amount, and (ii) the unused portion of the basic exclusion amount of the last deceased spouse of such surviving spouse.

Portability is available without regard to the size of the estate of the decedent or the reason for the decedent having an unused exclusion amount. For example, a taxpayer that dies in 2015 with a $2,000,000 taxable estate leaves $3,430,000 of portable exclusion. Similarly, a taxpayer that leaves a $20,000,000 estate who leaves $2,000,000 in taxable form and $18,000,000 to his or her spouse (or to charity), also leaves $3,430,000 of portable exclusion.

The applicable exclusion amount also applies for gift tax purposes, but does not apply to the generation-skipping transfer tax exemption.

IRC §2010 limits the surviving spouse to use of the unused exclusion of his or “last deceased spouse.” This limitation applies regardless of whether the last deceased spouse has any unused exclusion or whether the last deceased spouse’s executor makes or fails to make a timely election. The last deceased spouse rule means that a surviving spouse can lose some or all of his or her DSUE amount if he or she remarries and has another spouse predecease him or her.

IV. The Portability Election

To qualify for portability, the deceased taxpayer must have a surviving spouse and the executor must make the portability election on the decedent’s timely filed estate tax return. The Form 706 must be filed within nine months from the date of death, and if extended, six months thereafter. The DSUE amount must be calculated on such return.

The importance of discussing with your clients the portability election cannot be stressed enough. Even if the surviving spouse is unlikely to need the DSUE amount, caution dictates advising the surviving spouse and/or executor to make the portability election.

If portability is not desired, there are three ways in which the executor can “opt out” of portability. First, the executor can state on Form 706 that the estate is opting out of portability. Second, the executor could check the box on the Form 706. Third, the executor can opt out by simply not timely filing a Form 706. The election is irrevocable after the due date for filing the Form 706 has passed (including any actually granted extensions).

V. Portability Analysis

It is important to analyze portability in the context of the current tax environment and the non-tax factors that impact all estate planning. The single biggest development impacting planning with portability is the increase in the applicable exclusion amount to $5,000,000 indexed for inflation.

The main advantage of portability is simplicity. It allows a married couple to prepare a simple estate plan that leaves all property to the surviving spouse (in trust or outright) while still preserving the deceased spouse’s applicable exclusion amount. The primary income tax benefit of using portability is the assets passing to the surviving spouse will receive another step-up in basis at the surviving spouse’s death. This basis bump on the second death is not available in traditional credit shelter trust planning.

Many practitioners have conducted analyses of the benefits of traditional estate planning versus portability. Many of these studies focus on the trade-off of estate tax savings versus lost step-up in basis.

Although there are many variables in the analyses, in estates well under the spouses’ combined exclusion amount, portability is superior from a purely tax standpoint because of the certainty of a full income tax basis step-up at the second death.

VI. Conclusions on Portability

An election to use portability can save applicable exclusion amount that otherwise would be lost. As with all planning, myriad factors play into the analysis of whether or not to elect and use portability. Attorneys should view portability as another arrow in the quiver, but not necessarily the best arrow. In estate planning, the best approach is to maintain flexibility. Estate planners should continue their discussions with clients regarding the use of both traditional planning and portability to achieve the best result for each client.

 

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