$aving Estate Tax Through Portability

Posted on: February 17th, 2012 by Lawrence A. Friedman

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 exempts from federal estate tax the first $5 million of a decedent’s taxable estate. In 2012, inflation adjustments increased the exemption to $5,120,000. However, the exemption is scheduled to drop to $1 million after 2012 unless Congress intervenes.

Because each decedent has his/her own exemption, couples can leave twice the individual exemption (i.e. $10 million if the individual exemption is $5 million) to children or other beneficiaries without federal estate tax. However, the exemption of the spouse who dies first typically will be wasted without careful tax planning. To take advantage of both spouses’ federal estate tax exemptions, couples can leave the first spouse’s exemption to persons other than the surviving spouse or a trust that isn’t includible in the surviving spouse’s estate (often called a credit shelter trust). Credit shelter trusts are a popular estate planning technique because they can save state as well as federal estate tax and serve as a rainy day fund for a surviving spouse. Still, some couples prefer to leave amounts to the surviving spouse outright.

Until the 2010 tax act, amounts left to a surviving spouse outright would forfeit the first spouse’s exemption. After the 2010 act, the unused federal estate tax exemption of the spouse who dies first may be used by the surviving spouse provided portability applies. For instance if a husband dying in 2011 leaves a $4 million estate and his wife dies with a $7 million estate at a time when the federal estate tax exemption is $5 million, the wife’s estate would pay tax on $2 million without portability but only $1 million if portability applies.

Portability is available to a surviving spouse only if the estate of the spouse who dies first elects it on a properly filed federal estate tax return. Estate tax returns are due nine months from the date of death but an extension can be taken to extend the filing date an additional six months. IRS has granted estates of decedents who died during the first six months of 2011 an extension to elect portability provided the estate files IRS Form 4768 requesting an extension no later than fifteen months after the decedent’s date of death.

Portability can save substantial potential federal estate tax when the second spouse dies. Therefore, it usually will be desirable for the estate of a first spouse to die to elect portability. However, this would entail the expense to prepare and file a federal estate tax return, which may not be required otherwise.

While portability is beneficial for sure, it isn’t a panacea. For instance, portability won’t save state estate tax unless so provided in state law. Thus, a portability election may reduce potential federal estate tax when a second spouse dies but as of this writing it won’t protect against New Jersey estate tax. To minimize New Jersey estate tax as well as federal estate tax, couples should execute credit shelter trust wills while both are able and elect portability when the first spouse dies. In addition, most people should have powers of attorney and health care advance directives to avoid the need for guardianship down the road. Once the first spouse dies, it is too late to engage in credit shelter trust will planning.

Estate tax planning is complicated, and one size fits all estate plans rarely serve users well. At FriedmanLaw, we seek to develop effective estate plans to meet your non-tax goals and reduce potential tax. Contact us if you’d like to discuss your particular situation.

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Homepage photo: Cows grazing at Meadowbrook Farm, Bernardsville, NJ by Siddharth Mallya. October 23, 2012.
Interior photo: Somerset hills pastoral scene by Lawrence Friedman.