For years now, a surviving spouse has had the ability to claim the unused Estate Tax credit left behind by a deceased spouse. This credit is called a ‘Deceased Spouse Unused Election’ (DSUE for short) and is commonly referred to as ‘portability.’ In theory this filing is a ‘no-brainer’ - take the free tax credit even if you’ll never need it. In practice, the procedure for claiming the credit is both burdensome and quite time-sensitive. That, coupled with historically high exemptions, has led to very few estates electing to use this tax break. Now that there is talk Congress may reduce the exemption from its current all-time high of 11.7 million dollars to something lower (perhaps 5 million or 3.5?), many are considering a portability filing who would have dismissed it in the past.
1. How the Federal Estate Tax Works.
Here’s a primer on how the Federal Estate Tax works- many of our clients and friends lost track after the exemptions climbed to numbers higher than their estate will ever need. The math is fairly simple:
- Gross Estate – Exemption = taxable estate
- Taxable estate x tax rate = tax due
For a million dollar estate in 2021, the math has been simple because the exemption is more than eleven times the estate- there is no tax due. A fifteen million dollar example provides a better illustration:
- $15,000,000 - $11,700,000 = $3,300,000 taxable estate
- $3,300,000 x 40% = $1,320,000 tax due
I know many readers are losing interest- most do not have a fifteen million dollar estate and no one likes tax math. But these next two points are key. First: prior to 2001, the exemption was a piddly $675,000 and the tax rates ran from 40-55%. It was not too long ago that our estate planning classes focused on the estate tax and probate was only an afterthought. Second: there is a very real chance upcoming Federal Tax changes may drop the exemption to levels that affect many of our clients by the end of the year.
I could talk about the estate tax all day, but for the sake of the few readers still following, let me progress to the next concept, portability.
2. What Portability Is and How to Get It.
Portability occurs when a surviving spouse files an estate tax return for the purpose of calculating and capturing any Estate Tax credit left unused in the estate of the first spouse to die. Formally, this is called the Deceased Spouse Unused Election (DSUE). The term ‘election’ here means a decision made by checking a box on a tax return. A DSUE election must be made on a form 706, which is the Federal Estate Tax return.
Completing a form 706 is no small task- it is more daunting than the 1040 income tax form with which you are familiar. The filing must be done (or an extension must be requested) within 9 months after death. Surviving spouses often have not even considered filing for portability before the opportunity to file passes. A 706 is not a ‘do it yourself’ document. A taxpayer will fork over thousands of dollars for a tax preparer to work on that return.
3. To Elect DSUE/Portability or Not?
There are two reasons to file for portability after the death of a spouse:
- When an estate exceeds the exemption or is likely to in the future,
- A surviving spouse in concerned the Federal exemption may fall to a level that affects the estate before the death of the second spouse.
There are two reasons not to:
- A taxpayer is not concerned they will have a taxable estate,
- A surviving spouse does not want to invest the time and resources into preparing the 706 return.
Many believe that the Federal Estate Tax exemption will fall to a level between $3.5 and $5 million. Some think the Estate Tax may be repealed (personally I am very skeptical of that view). Regardless, no one knows what tax code changes this Congress and administration will enact and, further, no one knows what future administrations and Congresses will do. Filing for portability is an act of hedging one’s bets and taking protective action that in many cases might be unnecessary.
Most taxpayers do not file for portability. Of course, most Americans have an estate well below the levels that would trigger Estate Taxes. For those with estates that now exceed three or five million dollars, or that might do in the future (consider growth, inheritances, inflation, etc.), portability is something to be seriously considered. Many spouses make good decisions to file or not to file, but you want to make sure you make a decision by weighing the pros and cons in your case and not by forgetting to act until after the nine-month time limit has expired.
4. How This Compares to an A/B Trust.
Many JGB clients have a Living Trust plan that includes estate tax provisions. These are still good and still work. Choosing to file a DSUE election can be done in lieu of living trust planning or in addition to it. You will always want to talk to your lawyer and tax advisor before making any Estafte Tax, portability, or DSUE filings.
5. Conclusion.
With Federal Tax Exemptions at an all-time high rate, higher net worth estates are wise to claim any unused estate tax credit left behind at the death of the first spouse. This DSUE election on the form 706 is too involved a process for every estate, but estates in over three million dollars should seriously consider filing for portability.