What is Portability in Estate Planning? Portability for Estate Tax Exemption and Gift Tax

A couple spends a lifetime building their wealth, dreaming of passing it on to their loved ones. But without careful planning, a significant portion of their estate could be lost to taxes.

Now, imagine having a tool that ensures no part of their hard-earned exemption goes unused, allowing their legacy to thrive. Here enters portability in estate planning, which can be a game-changer for married couples looking to maximize their estate tax and gift tax benefits.

In this article, we will break down what portability is, how it works, and why it could be the key to securing your family’s financial future.

What is Portability in Estate Planning?

Portability is a valuable estate planning tool that allows the surviving spouse to inherit and utilize the unused portion of their deceased spouse’s estate tax exemption. In essence, it allows the surviving spouse to effectively double their estate tax exemption.

How Does Portability Work?

• Estate Tax Exemption: Each individual has a federal estate tax exemption, which is the amount of assets they can transfer to heirs without incurring federal estate taxes.
• Unused Exemption: If one spouse dies without using their entire exemption, the remaining unused portion can be “ported” or transferred to the surviving spouse.
• Combined Exemption: The surviving spouse can then combine their own exemption with the unused portion of their deceased spouse’s exemption, resulting in a significantly larger overall exemption.
• Tax Savings: This increased exemption can lead to substantial tax savings for the surviving spouse’s estate.

Example:

If a couple has a combined estate of $20 million and one spouse dies with an unused exemption of $5 million, the surviving spouse can “port” that $5 million to their own exemption, resulting in a total exemption of $18.61 million (assuming the current exemption of $13.61 million per person). This significantly reduces the potential estate tax liability for the surviving spouse’s estate.

Portability and Lifetime Gift Tax Exemption

Portability also interacts with lifetime gift tax exemptions, offering additional benefits. The lifetime gift tax exemption allows individuals to make significant tax-free gifts during their lifetime, reducing the taxable estate.

When portability is elected, a surviving spouse not only retains their own exemption but can also utilize the unused portion of their deceased spouse’s exemption for lifetime gifts. This combined exemption can be strategically leveraged to maximize wealth transfers while minimizing estate and gift tax liabilities.

In 2024, individuals can give up to $18,000 annually to another person without incurring federal gift tax obligations. There is no restriction on the number of gifts that can be made, and married couples can double this amount by choosing to split gifts.

For example, a husband and wife with two children can each give $36,000 annually to each child, totaling $72,000, without triggering a taxable gift or impacting their lifetime federal exclusion, provided no other gifts affect it. Once these gifts are made, they are excluded from the parents’ taxable estate.

The annual gift tax exclusion ensures that qualified gifts do not count against the lifetime exclusion amount.

If a person gives more than $18,000 to a single recipient within a year, it results in a taxable gift, requiring the individual to file a federal gift tax return (IRS Form 709). However, this doesn’t automatically result in taxes being owed. Instead, the amount exceeding $18,000 is deducted from the individual’s lifetime combined gift and estate tax exemption of $13.61 million.

For instance, if a father gifts $118,000 to his daughter in 2024, the taxable portion of the gift would be $100,000 ($118,000 minus the $18,000 exclusion). The father wouldn’t need to pay any immediate taxes on this taxable gift. Instead, the $100,000 would be subtracted from his lifetime exemption, reducing it from $13.61 million to $13.51 million.

If you anticipate that your estate might exceed the applicable threshold, implementing a thoughtful long-term gifting strategy can help safeguard your wealth for your heirs while minimizing exposure to potential transfer taxes.

Limitations and Conditions of Portability

Understanding the limitations and conditions tied to estate planning tools is crucial. These factors can significantly impact the effectiveness of your strategy, which is why it’s important to evaluate them carefully before implementing any plan.

1. Only Available to Married Couples

   • Restriction: Portability is exclusively available to married couples. Unmarried individuals, even in long-term relationships, cannot benefit from this provision.
   • Effect: This limitation makes it less inclusive for non-traditional families or cohabitating partners who do not have the legal status of marriage.

2. Must Be Elected by Filing a Federal Estate Tax Return

   • Requirement: The executor of the deceased spouse’s estate must file IRS Form 706 (Federal Estate Tax Return) to elect portability.
   • Deadline: This election must be made within nine months of the spouse’s death, though a six-month extension may be granted if requested in time.
   • Failure to Act: If the return is not filed or the election is not made, portability is lost, even if the deceased spouse’s estate would otherwise not require filing.

3. Subject to Lifetime and Gift Tax Exclusions

   • Cumulative Limits: The surviving spouse’s portability benefit is tied to the unused estate tax exemption of the deceased spouse. However, this combined exemption is still subject to the federal lifetime gift and estate tax exclusion limit.
   • Example: If the surviving spouse exhausts their exemption through large gifts, the portability benefit may no longer apply.

4. Does Not Apply to State Estate Taxes

   • Federal Limitation: Portability is a federal provision and does not automatically extend to state-level estate or inheritance taxes.
   • Impact: States with lower estate tax exemptions than the federal threshold may still impose taxes on the estate, reducing its value.

5. Not Indexed for Inflation for the Deceased Spouse

   • Frozen Amount: The unused exemption ported from the deceased spouse is fixed based on the amount available at their time of death.
   • Limitation: While the surviving spouse’s exemption may adjust annually for inflation, the ported exemption remains static, potentially reducing its future value.

6. No Automatic Portability Between Multiple Marriages

   • One Deceased Spouse Rule: A surviving spouse can only claim the unused exemption of their most recently deceased spouse.
   • Complexity: If the surviving spouse remarries and the second spouse also dies, the unused exemption from the first spouse is forfeited.

7. Does Not Protect Against Asset Appreciation

   • Taxation on Growth: While portability helps transfer unused exemptions, it does not shield the estate from taxes on asset appreciation after the first spouse’s death.

8. Limited to U.S. Citizens

   • Portability is available only to U.S. citizens or qualifying resident aliens. Non-citizen spouses generally cannot use portability unless specific trusts, such as a Qualified Domestic Trust (QDOT), are established.

Portability is a powerful tool in estate planning that allows a surviving spouse to utilize the unused estate tax exemption of their deceased partner. When implemented properly, it can significantly minimize future tax liabilities and ensure that more wealth is preserved for heirs.

However, navigating the process involves complexities, including strict deadlines, accurate asset valuation, and meticulous filing with the IRS. To make the most of this strategy, it’s essential to work with an experienced estate planning attorney who can guide you through the intricacies of portability and ensure compliance with all requirements.