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.
