Portability — it may not be too late

By Nancy Burner, ESQ.

The concept informally known as “portability” is now permanent as a result of the enactment of the American Taxpayer Relief Act of 2012. Portability allows a surviving spouse to use a deceased spouse’s unused estate tax exclusion (up to $5.43 million in 2015).

For those dying in 2011 and later, if a first-to-die spouse has not fully used the federal estate tax exclusion, the unused portion called the “Deceased Spousal Unused Exclusion Amount,” or “DSUE amount,” can be transferred or “ported” to the surviving spouse. Thereafter, for both gift and estate tax purposes, the surviving spouse’s exclusion is the sum of (1) his/her own exclusion (as such amount is inflation adjusted), plus (2) the first-to-die’s ported DSUE amount.

For example: Assume H and W are married, and H dies in 2015. H owns $3 million and W owns $10 million. H has the potential of leaving up to $5.43 million under federal estate tax to a bypass or credit shelter trust, which would avoid federal estate tax in both spouses’ estates.

However, because H only has $3 million, he does not take full advantage of the $5.43 exclusion. Prior to portability, $2.43 million would have been wasted. With portability, his $2.43 million can be saved and passed to W’s estate, increasing the amount she can leave heirs free from federal estate tax. With a 40 percent federal estate tax rate, this would save W’s estate approximately $972,000 in federal estate tax. 

With this plan, the estate would also avoid New York State Estate Tax at the husband’s death since the current exclusion is $3.125 million. The assets in this bypass trust would escape federal and New York estate taxation at W’s subsequent death.

In order for the surviving spouse to be able to use the unused exemption, the executor of the first-to-die’s estate must make an election on a timely filed estate tax return. A timely filed return is a return filed within nine months after death or within 15 months after obtaining an automatic extension of time to file from the IRS. Normally a federal estate tax return is only due if the gross estate plus the amount of any taxable gifts exceeds the applicable exclusion amount (up to $5.43 million in 2015). However, in order to be able to elect portability, a federal estate tax return would have to be filed even if the value of the first-to-die’s estate was below the exclusion amount.

The problem occurs when the first spouse dies and no estate tax was filed. In that event, the second-to-die spouse could not use the deceased spouse’s unused exemption. In the above example, the second spouse’s estate would have paid an additional $972,000 in estate taxes if the election was not made. What if the first spouse dies, no estate tax return is filed and no election was made on a timely basis? Does the surviving spouse lose the exemption?

In June 2015 the IRS issued its final regulations on portability. The final regulations make clear that the issue of whether an estate may obtain relief for making a “late” portability election will depend on whether or not the first estate was required to file an estate tax return.

In the instance where the first spouse’s estate was taxable and required to file an estate tax return (because the value of the estate was over the exclusion amount), the time to timely file was nine months from date of death of the first spouse or six months later, if an extension was requested and granted. If that estate tax return was not filed, then the IRS cannot extend the time to file and elect portability. 

If the estate is not required otherwise to file an estate tax return because the value of the estate is below the exclusion amount, then the IRS may grant relief via a private letter ruling. A private letter ruling, or PLR, is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer’s represented set of facts. A PLR is issued in response to a taxpayer’s written request. The PLR may not be relied upon as precedent by other taxpayers. 

When seeking a PLR allowing the estate to file late portability election, there are some burdens that must be met. First, the election must be made by the representative of the estate, which may or may not be the surviving spouse. The representative will have to show that he or she acted in good faith and that this ruling will not prejudice the interests of the government. This option is generally available where there was either an oversight in handling the first spouse’s estate or the taxpayer was the victim of bad advice from an accountant or attorney.

For those that had spouses pass away after Jan. 1, 2011, portability can be a valuable estate planning tool to save a significant amount of federal estate tax on the death of the second spouse. If a surviving spouse has assets that are close in value to the current federal exclusion amount, it is important to examine the records of the deceased spouse to make sure that a portability election was made on a timely filed federal estate tax return. If no return was filed, and no estate tax return was required to be filed, it may not be too late to apply to the IRS for a private letter ruling.

Nancy Burner, Esq. has practiced elder law and estate planning for over 25 years.