In November 2022, the IRS issued a new procedure that simplifies the process for taxpayers who want to make a Portability election. Since it can be very impactful for estate planning, let's take a look at what it is and how it can be used.
Prior to the introduction of portability, spouses only enjoyed the individual exemption for their estates. This was at odds with the standard deduction, which allowed married couples to treat themselves as a single economic unit. Also, no gift or estate tax was imposed on transfers between spouses. With the new rule, all of the property owned by one spouse after their death can pass to their surviving spouse without any estate or gift implications.
Portability can help the surviving spouse's estate by allowing all of the assets held by one spouse to pass to their surviving spouse without any estate or gift implications. For instance, in 2022, a married couple with $20 million in assets would not have to use the $12.06 million exemption when the first spouse passes away. However, the surviving spouse then dies with a taxable estate of around $20 million, and the estate tax rate is 40%.
This situation led to the development of credit shelter trust planning, also known as bypass trusts. When a spouse passes away, their assets are placed into a trust, which is then controlled by the surviving spouse. This type of trust can help preserve the first spouse's estate exemption, and it can also prevent the assets from being included in the surviving spouse's estate.
In 2013, the federal tax law known as Portability was made permanent. This made it easier for married couples to carry out estate planning.
Portability was used to allow the surviving spouse to take advantage of the deceased spouse's unused exemption. For instance, in this example, the surviving spouse had $24.12 million of exemption after the first spouse passed away in September 2022. Without owing taxes, the surviving spouse now has a total estate of $20 million.
The implementation of permanent portability and the concept of treating married couples as a single unit brought about the same level of estate taxation as the unlimited marital deduction. As a result, there are still some estate planning items that can be addressed permanently.
One important note about portability is that it only works in federal law. In the states that have their own estate taxes, only Maryland and Hawaii allow for the same portability between spouses. This means that estate planning in these states can be affected by additional tax planning techniques. For instance, credit shelter planning can be very effective for individuals who are planning on using credit to preserve their assets.
Although credit shelter planning was the "go-to" technique for many individuals before the implementation of permanent portability, many estate plans still feature various aspects of it that are no longer necessary. For instance, if a client's estate plan has several components that are not related to portability, it is important that they review and update their plans to accommodate the new legislation.
One of the key components of portability is that it requires the surviving spouse to make the election. In the IRS Revenue Ruling issued in November 2022, it allowed the surviving spouse to make the election on the estate of the deceased spouse that was large enough to require a Form 706.
Although the threshold for filing was not met for deceased spouses' estates, the surviving spouse was allowed to make the election up to five years from the death of the spouse. This new window is very important for individuals who have potential estate tax liability. It is also important to note that the current exemption levels will expire in 2025.