Surprising to most people, the federal estate tax is a voluntary tax.  Estate planning attorneys used to say, “You only pay if you don’t plan.”  Now, portability provides both an alternative and a back up plan to lifetime tax planning.  This means you might be able to minimize or even eliminate federal estate taxes even if you didn’t plan.  Here’s how.

Portability allows married couples to use two estate tax exemptions and save significant amounts in estate taxes without lifetime planning and without the division of assets.  This planning option first appeared in 2010, but, because it was a temporary measure, many estate planners were hesitant to rely on it.  It became permanent law in 2013 and is now considered a viable tool for many married couples.

The Key Takeaways:

• EVERYONE still needs lifetime estate planning to protect themselves, their families, and their assets.  (Estate planning is not just about tax planning and it’s not just about money.)

• The failure to use both federal estate tax exemptions may cause an unnecessarily high tax bill for married couples. 

• Portability lets married couples use both of their exemptions without lifetime tax planning.

• Portability is not automatic—an estate tax return must be filed after the death of the first spouse, generally within nine months.

• Trust planning is still highly useful for both tax and non-tax reasons (e.g., asset protection and family line protection) and can be used with or without portability.

How Portability Works:

When portability was made permanent in 2013, Congress also made the $5 million federal estate tax exemption permanent (with annual increases tied to inflation).  As a result, most families don’t have to worry about federal estate taxes.

However, if your net estate is more than $5 million and you are married, portability allows your surviving spouse to use your individual estate tax exemption as well as his or her own, allowing the transfer of up to $10+ million in assets with no estate taxes, saving millions from Uncle Sam’s clutches.

Unlike trust tax planning, which must be done while both spouses are alive, portability is available after the first spouse dies and is a valuable back-up plan for couples that neglected lifetime tax planning.

Note: Portability is not automatic. An estate tax return (Form 706) must be filed within nine months after the death of the first spouse, or within any extension granted. If no timely return is filed, portability and the deceased spouse’s unused exemption (estate planning attorneys call this the “DSUE”) are forever lost, perhaps, causing the estate to pay more in estate taxes than was necessary and leaving less for the family.

Interestingly, remarriage does not change the identity of the most recently deceased spouse, and a surviving spouse can use multiple DSUEs.

Here’s an example:

Bob and Sue were married for many years.  When Bob died, Sue’s attorney filed an estate tax return, thereby “electing” portability. Some time later, Sue married Phil. She decided to use Bob’s DSUE during her lifetime and made gifts to their children.

When Phil died a few years later, Sue’s attorney filed an estate tax return for Phil’s estate, making portability available.  In addition, when Sue died, her estate was able to use both her exemption and Phil’s DSUE.  Sue was able to use three federal estate exemptions and completely avoided the federal estate tax.

Keep in mind that if Sue had not used her first husband’s (Bob’s) DSUE before Phil died, it would have been wasted.  Why is this?  Because Phil would have become her most recently deceased spouse.

What You Need to Know:

Trust planning can be used with or without portability and is still highly relevant for couples with any size of estate.

When there are children involved, especially if they are from a previous marriage or relationship, trust planning can allow the first spouse who dies to provide for the surviving spouse and keep control over who will eventually receive his/her share of the estate.

In addition, trust planning can protect assets from a beneficiary’s irresponsible spending, creditors, medical crises, lawsuits, and divorce proceedings, allowing the assets to remain within the family for generations to come. Trust assets can also provide for a special needs beneficiary without losing valuable government benefits.

Actions to Consider:

1. Ask your estate planning team when you need to be concerned about state estate taxes and state inheritance taxes.  (Some states have their own death/inheritance tax, often with a lower exemption than the federal estate tax. As a result, it is possible that an estate will be subject to state taxes even though it is exempt from federal taxes.)

2. When a spouse dies, ask your estate planning attorney whether using portability is appropriate for you.  (Most married couples can benefit from portability, even if only as a preventive estate planning measure.  The value of assets may increase to more than one exemption before the surviving spouse dies.)

3. If your second (or third) spouse is seriously ill, ask your estate planning attorney you should use any remaining DSUE to make lifetime gifts to beneficiaries.

4. Ask your estate planning attorney whether the generation skipping transfer (GST) tax is a factor for you.  The GST tax is not portable and needs its own planning analysis.

5. When your spouse dies, be sure the estate tax return (Form 706) is prepared and filed by a qualified professional such as an estate planning attorney.

6. Ask your estate planning team about non-tax trust protections such as asset protection and family line protection.

 If you are interested in ensuring that your family is cared for after you have passed away, please call our office at 415-625-0773 to schedule your free estate planning consultation with San Francisco’s premiere estate planning attorney, Matthew J. Tuller.