IRS Gives Estates a Second Chance at Portability
If you have become a widow or widower since December 31, 2010, or if you were made an executor of the estate of someone who died after that date, a Revenue Procedure (“Rev. Proc.”) issued by the IRS can significantly reduce future taxes. Rev. Proc. 2017-34 allows certain estates to make a late portability election if an election wasn’t made on time.
What Is Portability and What Changed?
In the simplest terms, portability means that if the estate of a deceased person doesn’t use his or her full exemption from federal Transfer (Estate and Gift) Taxes, the surviving spouse can use that unused exemption for his or her own estate. Currently, the exemption is $5.49 million (the exemption is indexed for inflation, so it tends to increase a little from year to year). So, if a person dies without having made any gifts subject to transfer taxes and his or her estate is worth $4 million, they aren’t using $1.49 million of the Transfer Tax exemption. That $1.49 million can be carried over (or “ported”) to the surviving spouse, increasing the spouse’s exemption to $6.98 million. An estate can generally only elect portability by indicating that it wants to do so on an Estate Tax Return (Form 706) filed within nine months of the decedent’s death (with the ability to get an extension for an additional six months if needed).
The purpose of this particular Rev. Proc. is to provide relief for the surviving spouses of those estates that were under the exemption amount and that failed to file an estate tax return on time in order to elect portability. This relief is only available in situations where the combined value of assets held at death and gifts made during the decedent’s lifetime didn’t exceed the current Transfer Tax exemption amount.
As a result of this Rev. Proc., an estate that is smaller than the exemption amount now has two years from the date of death to file a return and elect portability. If an individual died after December 31, 2010, the date is extended until January 2, 2018, even if that date falls outside the two-year window. In order to obtain this relief from the usual filing deadline, the return must be filed within these time frames with a statement at the top of the first page of the return that states: “FILED PURSUANT TO REV. PROC. 2017-34 TO ELECT PORTABILITY UNDER SECTION 2010(c)(5)(A).”
How Transfer Taxes and Portability Work
U.S. estate tax and gift taxes are normally imposed on transfers of assets at rates that can be as high as 40 percent. However, certain transfers are exempt. Individuals can transfer assets valued at up to the $5.49 million exemption tax free, whether during their lifetime or at death. Gifts and bequests to a spouse who is a U.S. citizen or to a charity don’t count against one’s personal exemption. In other words, you could leave your spouse $6 million and leave your favorite charity $1 billion and still give your children up to $5.49 million, and it would all pass tax free.
Prior to 2011, if an individual left everything to his or her spouse, then all assets qualified for the marital deduction and none of the exemption was needed or used. However, that individual’s exemption was lost. So, if a married couple’s total assets exceeded the exemption, the Estate Tax would be due at the second spouse’s death unless proper planning was implemented.
The rules allowing portability became effective in 2011. Now, a widow(er) can claim the unused exemption from the estate of his or her deceased spouse. This basically doubles the amount of assets that can be passed tax free at the second spouse’s death if neither spouse has transferred assets to third parties.
For example, for this scenario, let’s assume a woman passes away in 2017 and that she made taxable gifts of $1.35 million during her lifetime. At death, she leaves $500,000 to her children and the remaining assets to her spouse. The applicable exemption amount available at death to the deceased’s estate would be $4.140 million ($5.49 million – $1.35 million). The unused amount portable to the surviving spouse would be $3.64 million ($4.14 million – the $500,000 bequest to children). Assuming the surviving spouse has $7.49 million of assets at his death and the exemption has not changed, he would owe approximately $800,000 ($2 million above exemption at a rate of 40 percent) in Estate Tax if portability is not elected. However, if they elect portability, no Estate Tax would be due, because the extra $3.64 million of exemption from the first spouse covers the excess $2 million of assets above the surviving spouse’s own exemption.
How to Claim Portability
Normally an estate tax return is not required to be filed unless the gross estate and lifetime gifts exceed the exemption amount for the year of death. However, if the value of the surviving spouse’s estate and lifetime gift-giving is expected to exceed the exemption amount, it is beneficial to file a return for the first deceased spouse in order to obtain the surviving spouse’s unused exclusion. Portability is not allowed unless an estate tax return is filed for the estate of the first spouse to die.
If a proper election was not made, the only way to correct the issue without relying on this Rev. Proc. would be by requesting a letter ruling under Treasury Regulation Section 301.9100-3. However, the IRS charges $10,000 for the consideration of a ruling request.
The first step is to determine whether a late portability election would help reduce future Transfer Taxes. If you need help or have questions while reviewing your situation, from determining a need for portability to filing the right forms, get in touch with Mike Kirkman, CPA, Partner and National Leader of Estate, Gift and Trust Services with Cherry Bekaert. Our team can also help you get the answers you need, so you can make sure your current estate plan meets your needs now and in the future – when your family will need it most.