The estate tax exemption, i.e. the amount you can transfer at death without incurring a federal estate tax, has fluctuated widely over the years. For example, in 2004, it was $1.5M ($3M for married couples), which many middle class families needed to take seriously when they considered assets such as retirement and life insurance. Under the marital deduction, one spouse can pass an unlimited amount to the surviving spouse without incurring estate taxes. Since the estate tax was not automatically portable between spouses, without the use of a family trust, the exemption of the first spouse to die was wasted. E.g., if a couple had a combined estate of $3M and did not establish a family trust (enabling them to “stack” their exemptions), $1.5M would be subject to estate tax.
What is Portability? The 2014 exemption is $5.34M and indexed for inflation. The American Taxpayer Relief Act permanently added portability, which permits the surviving spouse to carry over the deceased spouse’s unused exemption (“DSUE”) and add it to his own, to the tax code. Although Congress intended portability to simplify estate taxes for the middle class, its initial application in practice has caused confusion. The general public has been lulled into believing that portability is automatic.
Who might benefit from Portability? Any surviving spouse who projects that his estate might exceed the single exemption might benefit. Keep in mind that the exemption may be reduced by Congress. The expense of filing an estate tax return (which is sometimes complicated by the expense of appraising assets) may be cheap insurance to preserve both exemptions, especially given how frequently the exemption has fluctuated over the years. This sometimes becomes tricky in blended families (e.g., if the deceased spouse’s personal representative, a child from the first marriage, is unwilling to incur the expense to benefit the surviving spouse, who is a step-parent).
How Do I Elect Portability? A portability election must be made by filing an estate tax return (IRS Form “706”) within 9 months from date of death. When no estate tax is due, the sole effect of filing a 706 is to preserve DSUE for the survivor.
What if I Missed the Portability Election Deadline? Recognizing that portability was a new concept for taxpayers and receiving many requests for extension via private letter ruling, the IRS issued Revenue Procedure 2014-18. Where a taxpayer meets the following conditions, the IRS will grant an extension:
- Taxpayer is the executor of the estate of a decedent who (a) has a surviving spouse, (b) died between December 31, 2010 and December 31, 2013 and (c) was a citizen or resident of the United States on the date of death;
- Taxpayer did not need to file an estate tax return strictly based on the value of the gross estate; and
- Taxpayer did not timely file a portability IRS Form 706.
Who might benefit from the Grace Period? Same-sex couples whose marriages are now recognized following U.S. v. Windsor, 133 S.Ct. 2675 (2013), the landmark Supreme Court Case which held unconstitutional § 3 of the federal Defense of Marriage Act (“DOMA”), might benefit. Windsor involved a same-sex couple married in Canada and rectified the survivor’s inability because of DOMA to stack the couple’s estate tax exemptions. In Revenue Ruling 2013-17, the IRS recognized the marriage of same-sex couples for Federal tax purposes effective September 16, 2013. Since the IRS now recognizes same-sex marriages, the surviving spouse with an estate near $5.34M should consider electing portability under this extension.
Additionally, the estate of a surviving spouse (S2) which paid estate taxes because the first spouse’s (S1) estate failed to make a portability election may also benefit from this grace-period. In a second-marriage, for example, where S1’s estate was $2M and her children from her first marriage did not want to incur the expense of filing an estate tax return, this grace period might be helpful. Suppose that when S2 dies, his estate is $8M. S2’s estate files an estate tax return and pays taxes on the excess over $5.34M. With this grace-period, S1’s estate might be persuaded make a portability election and S2’s estate may request a credit or refund for overpayment (within 3 years from the date of filing of the return, or within 2 years from the date of payment of the tax).
These are just a few examples.
What Does this Mean for Me? It is tempting to put off seeing a lawyer after your spouse dies. After all, married couples typically hold most key assets in joint tenancy. Unfortunately, delay could cost your heirs unnecessary estate taxes. Call our Denver tax and estate planning attorneys today if you would like guidance through the legal process following the death of your spouse.