Though much has changed with regards to gift and estate tax planning since the Tax Cuts and Jobs Act (TCJA) was passed in 2017, one thing that was preserved was estate tax portability – a helpful tax benefit that should be considered when crafting your estate plan.

Preserving Estate Tax Portability

Essentially, estate tax portability allows the executor of an estate to exercise the option on behalf of the deceased’s spouse, to allow that spouse to use any available estate tax exemption amount that hasn’t yet been used at the time of the taxpayer’s death.

This works in tandem with the federal gift and estate tax exemption changes the TCJA exacted by way of doubling the existing $5 million exemption to $10 million.  Indexed for inflation, the TCJA also set out to increase that exemption over time, shifting it to $11.18 million in 2018 and again to $11.4 million in 2019.

The Evolution of Estate Tax Portability

Historically speaking, estate tax exemptions and estate tax portability have undergone multiple changes since the year 2000 when the exemption amount hovered at $675,000.  In 2002, the exemption was increased to $1 million.  It increased again to $3.5 million in 2009.

In 2010, the top estate tax rate was decreased from 55% to 35%.  At the same time, the Tax Relief Act (TRA) of 2010 also provided for an all-time-high estate tax exemption of $5 million. Two years later, the American Taxpayer Relief Act (ATRA) made these changes permanent while simultaneously increasing the top estate tax rate to 40%.

While the TRA authorized estate tax portability of the exemption, the ATRA permanently preserved portability.

The DSUE in Practice

Under the estate tax portability provision, the executor of the estate of the first spouse to pass away can elect to have the “deceased spousal unused exemption”, or DSUE, transferred to the estate of the surviving spouse. Here’s an example of the deceased spousal unused exemption provision in action and why portability and planning are so important.

Brad and Susan have two children.  Each spouse owns $5 million, individually, and together they own an additional $10 million (or $5 million each, with rights of survivorship) which brings them to an estate total of $20 million.  Their wills stipulate that, upon the death of either spouse, all assets will first be distributed to the surviving spouse and will then be passed on to their children.

Because of the unlimited marital deduction, if Susan had died in early 2019, her $10 million in assets would be exempt from estate tax and the full amount of her $11.4 million exemption would remain unused. However, if, upon Susan’s death, the executor puts into effect the estate tax portability provision, Brad’s estate has the opportunity to later use the $11.4 million of Susan’s DSUE in conjunction with the exemption for the year in which Brad dies, to protect the remaining $8.6 million from tax, with the additional money that comes from appreciation left over.

If the executor fails to enact the provision, though, the situation would ultimately paint quite a different picture.  Upon Brad’s passing, Susan’s exemption of $11.4 million would be lost and the remaining $8.6 million would be subject to the 40% estate tax rate which would mean $3.44 million that could have gone to their children will now go towards federal estate taxes, instead.

Other Factors Affecting Portability

It’s important to know that the estate tax portability issue as addressed here, affects federal estate taxes only, though your state’s estate taxes may substantially impact your overall tax exemption situation.  Additionally, when 2025 arrives, the estate tax exemption amount is scheduled to return to pre-2018 levels (though portability will continue for those who have exercised the option prior to 2025).

The responsibility for filing a Form 706 (United States Estate and Generation-Skipping Transfer) tax return to make the portability election in a timely manner falls to the estate’s executor, even if the estate tax return is not otherwise required to be filed.

You’ll want to be aware that portability may not be the right decision for your situation if, for example, you choose to divide your assets because of a divorce, remarriage, or other circumstances.

Because each person’s estate includes a number of unique factors that can impact your decision-making process, be sure to check with your Untracht Early advisor if you’re considering estate tax portability so we can offer guidance on the best course of action to take for you and your heirs.