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How Does Portability Work?

Transferring wealth from one generation, while paying the least amount in taxes, is the goal of estate plans where families have significant wealth, as well as regular people. In the past, this required complex tax planning and trust structures.

In 2010, the idea of making the federal lifetime estate tax exemption portable between married spouses was introduced. It changed how many estate plans are structured. Combined with the increased federal estate tax exemption, this has further changed estate plans.

The Monterey Herald recently reported, in the article “Financial planning: What you need to know about portability,” that the federal lifetime estate tax exemption determines how much wealth a person can leave to their family without being subject to estate tax. The current lifetime estate tax exemption is $11.4 million, which means that you can leave up to $11.4 million to your heirs, without the 40% estate tax on whatever remains.

With individual taxpayers, this is pretty straightforward. However, with couples, it becomes more complicated.

For example, assume a married couple has an estate worth $18 million. The husband dies first without using any of his estate tax exemption. The wife dies two months later, leaving the entire estate to their children. Without portability, it’s “use it or lose it” for the estate tax exemption.

When the husband dies, the entire estate passes to his wife (if she is a U.S. citizen) without any estate tax implications. This is known as the unlimited marital deduction rule. However, when the wife dies two months later, the estate will owe estate tax of $2.64 million, or the value of the estate above the wife’s $11.4 million exemption times the 40% estate tax rate.

That’s why trusts were so essential in pre-portability estate planning. Before portability, any unused estate tax exemption went to fund a bypass trust. The bypass trust was usually set up to provide for the health, education, maintenance, and support of the surviving spouse. The remaining assets went to the surviving spouse in a marital trust. The trust structure helped make sure the estate tax exemption of the first-to-die spouse was used to its fullest, but it also increased the paperwork with estate transfers.

With portability, the unused estate tax exemption transfers to the surviving spouse. In the example, the wife’s lifetime estate tax exemption after her husband’s death would be $22.8 million (her $11.4 million plus his unused $11.4 million.) When she dies two months later, the estate value of $18 million is below the combined lifetime exemption. Voila! No estate tax is owed.

Portability isn’t automatic. For a surviving spouse to claim the deceased spouse’s unused estate tax exemption, the decedent’s executor must file IRS form 706 within nine months of the decedent’s date of death. If you need more time, you can ask for an automatic six-month extension.

Your estate planning attorney will know how to utilize the best in tax planning, to maximize the amount of assets that your family can transfer from one generation to the next.

Reference: Monterey Herald (February 27, 2019) “Financial planning: What you need to know about portability”

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