You can save millions with estate tax portability. I often hear questions like, “What can I do to save estate taxes?” or “How do I avoid paying estate taxes?” You should know about portability.
Estate Tax and Estate Tax Exemption
Before diving into portability, we need to understand estate taxes. Estate tax is a tax on the transfer of wealth. Basically add up all of your assets on death and there is a tax on it. Currently the top estate tax rate is 40%. The rest can go to your heirs. But it’s actually not as bad as it sounds. A portion of the total estate is exempt from estate tax. We call this the estate tax exemption. The exemption changes year to year, and you can look it up on IRS.gov. In 2023 the estate tax exemption is approximately $12.92 million per person. This amount is indexed for inflation so it increases a bit each year.
Note that the exemption normally would be half of what it is today but a few years ago President Trump signed a law that temporarily doubled the estate tax exemption. That law expires at the end of 2025. So beginning January 1, 2026 the estate tax exemption will go back to it’s normal amount (meaning it will be cut in half). Also note that there is an unlimited exemption for assets going to a surviving spouse on death.
In 2023, if you have less than $12.92 million in assets at your death, you won’t owe any estate taxes. Anything over $12.92 million is taxed, with a max tax rate of 40%. Ouch. Remember though that this exemption amount applies to each individual. If you are married, each spouse has an estate tax exemption. And that exemption is “portable” to a spouse on death. With proper planning nearly $26 million per couple is exempt. That’s a lot of tax savings!
Historically, the estate tax exemption for spouses was a “use it or lose it” type of thing. Upon the first spouse’s death, you needed special provisions in your revocable trust that “used” the deceased spouse’s exemption. If you didn’t have those provisions, the deceased spouse’s exemption was lost, and when the surviving spouse died, they would only have their own exemption. This meant estate planning before a loved one passed away was essential.
All of that changed in 2011 when portability was introduced. Portability allows the surviving spouse to use the deceased spouse’s exemption without the need for special provisions in your revocable trust. Although there are many other reasons to still have a revocable trust. When the first spouse dies, the surviving spouse files an estate tax return within nine months to elect portability. The first spouse’s remaining exemption is then “carried” to the surviving spouse to use at their death. So when the second spouse dies, they have their own estate tax exemption plus any of the first spouses unused exemption.
How and When to Elect Estate Tax Portability
To elect portability you need to file an estate tax return within 9 months of the persons death. What if you don’t file an estate tax within 9 months of death? Is it too late to elect portability? The good news is that there is still time for most people. And it’s a huge planning opportunity. Many people don’t owe estate tax on death because their assets were less than their available exemption amount. In 2017 the IRS extended the time for electing portability to two years (if no estate tax is owed). Even better, in 2022, the IRS extended the time to elect portability to five years from the date of death (if no estate tax is owed). If you forgot to file an estate tax return to elect portability, there may be hope for you!
Here’s an illustration:
- Your spouse passes away.
- At the time you have about $6 million in assets, mostly of investment properties.
- You don’t need to file an estate tax return because all the property goes to you as the surviving spouse (unlimited exemption for transfers between spouses).
- 3 years later, you’re in a difficult spot. Due to a booming real estate market, the properties have appreciated, and are now worth about $10 million. Add in the bank accounts, 401(k), and life insurance proceeds, and your estate is approaching $12 million.
- Unfortunately, the estate tax exemption has shrunk from the approximately $12 million when your spouse died to $6 million at the time.
- Your estate is worth $12 million but you only have $6 million in exemption. It looks like you’ll be paying over $2 million in estate taxes. Ouch.
This is where portability comes to the rescue.
- You file a late estate tax return electing portability.
- Your deceased spouses unused exemption is transferred to you.
- The exemption was $12 million per person when your spouse died.
- So you’ll be able to carry that $12 million exemption forward to today.
- Add in your $6 million exemption, and you’ve got $18 million in exemption which is more than enough to cover your estate that is worth $12 million.
That means no estate taxes. Now that’s awesome!
If your net worth is close to or above the current exemption and your loved one died within the last five years, you should speak with an accountant and an estate planning attorney about portability. They’ll discuss whether portability will work for you and help you through that process. Portability can help you save millions of dollars in taxes at your death, so more can go to your beneficiaries.
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