Portability in Estate Planning

Case Study

24 Feb Portability in Estate Planning

The federal estate tax exemption for deaths in 2016 is $5.45 million. Married couples may be able to pass twice that amount—$10.9 million—to their heirs without triggering estate tax. Some planning is necessary to reach the higher level, but a relatively new tax code provision, known as portability, can simplify the process.

Traditional tactics

For decades, estate tax planning for married couples with substantial net worth involved asset shifting and trust creation.

Example 1: George Hall owns a small business valued at $4 million. George’s other assets (real estate, retirement plans, investments, etc.) total $3 million. If George dies and leaves everything to his wife, Irene, no estate tax will be due. Bequests to spouses usually avoid estate tax.

In this scenario, Irene would inherit George’s $7 million estate. Including the proceeds from a life insurance policy and her own wealth, Irene might have a net worth of $10 million.

Assuming Irene dies with that $10 million a few years later, when the estate tax exemption has risen to $6 million, her estate would be $4 million over the limit. With the current 40 percent estate tax rate on nonexempt assets, Irene’s estate would owe $1.6 million in federal estate tax (40 percent of $4 million), reducing the net payout to the Halls’ children, who are Irene’s heirs.

To avoid this tax, the Halls might set up trusts, to receive some assets at the first spouse’s death, untaxed because of the estate tax exemption. George also might shift some assets to Irene, so that a tax-effective trust could be funded regardless of which spouse is the first to die.

Easier does it

Recently, the concept of estate tax exemption portability has been introduced to the Internal Revenue Code. Under the portability rules, the surviving spouse can use the decedent spouse’s unused estate tax exemption if the executor of the decedent spouse’s estate makes a portability election on the decedent spouse’s estate tax return. Trusts and asset transfers can still be used but they may not be necessary.

Example 2: George Hall keeps his $7 million in total assets, which he leaves to Irene, as in example one. At his death in 2016, the executor of George’s estate files a federal estate tax return, IRS Form 706, making the portability election.

In example two, George has used none of his estate tax exemption, so all $5.45 million is transferred to Irene. If she dies in a year when the exemption amount is $6 million, Irene will have an $11.45 million federal estate tax exemption: her own $6 million plus $5.45 million from George. (These examples all assume that neither spouse made any taxable gifts). If Irene dies with $10 million in net worth, her $11.45 million exemption will allow it all to go to their children, free of federal estate tax.

Our office can help you determine whether using portability makes sense in your overall wealth transfer planning.

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