Dec 11, 2015

Portability of the Unused Spousal Exclusion

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 introduced the concept of portability.  Portability allows the executor of a deceased spouse’s estate to transfer any unused estate tax exemption to the surviving spouse, as long as the surviving spouse was a US citizen or resident. In simple terms, portability of the federal estate tax exemption between married couples means that if the first spouse dies and the value of the estate does not require the use of all of the deceased spouse’s federal exemption from estate taxes, then the amount of the exemption not used for the deceased spouse’s estate may be added to the surviving spouse’s exemption when the surviving spouse later dies.

Important note that with regard to state estate taxes, currently only Hawaii offers portability at the state level, and Maryland will begin offering portability of its state estate tax exemption beginning in 2019. Under the 2010 Act, this provision was to apply to estates of individuals who died after 2010 and before 2013. The American Taxpayer Relief Act of 2010 made the portability provisions permanent. The statute allows the deceased spouse’s unused exclusion (DSUE) amount to be made available to the surviving spouse only if the predeceased spouse’s executor elects portability on “timely filed” (including extensions) and “complete and properly prepared” estate tax return. Even if a federal estate tax return is not required to be filed (due to net asset value) an estate tax return must be filed solely to elect portability and must be “complete and properly prepared”. The normal time prescribed for filing a federal estate tax return is nine months after the date of the decedent’s death, although the executor may claim an automatic extension of six months making the extended due date 18 months after the date of the decedent’s death. This is the only way to make the portability election.

Not since the estate law was amended in 1981 has there been such a significant change in the estate tax laws. Portability represents a breakthrough in estate planning, because it potentially eliminates the risk of losing part or all of the lifetime exclusion of the first spouse to die if it was not fully used at the death of the first spouse.

The DSUE amount can be lost if the surviving spouse marries another spouse (the second spouse) and the second spouse predecessors the surviving spouse. The reason for this is the statues provides that the surviving spouse can get the benefit of the DSUE amount of such surviving spouse’s “last deceased spouse.” When the second spouse dies, she/he becomes the last deceased spouse of the surviving spouse, so the DSUE amount of the surviving spouse’s first spouse disappears and is replaced by the second spouse’s DSUE amount.

In general, when you consider remarrying, one should consider all the consequences of a second or third marriage including a previous ported DSUE amount from a prior deceased spouse. Portability may raise other issues that could potentially lead to divisive situations.

Some of these issues may be:

Do both parties agree that upon the death of the first to die that portability will be elected?

If this is not a first marriage, who pays for the portability election to claim the DSUE if no estate tax return is required to be filed for the deceased spouse.

Provide a mechanism to ensure that the surviving spouse will cooperate in making the portability election.

Addressing this, and other issues, potentially avoid conflicts that may arise at the time of the spouse’s death. It is highly recommended that estate planning be incorporated in pre-marital documents especially in situations where the parties have been married before or have complex family structures.

Portability may have initially been viewed as the simple solution in situations where there was the potential for loss of a unified credit of the first spouse to die. Estate planning and family planning today and for the future requires a deeper understanding of how portability works and how it can be integrated into your estate plan.