Estate planning could seem daunting, but it can also be made simpler by understanding key concepts. One of which focuses on the “portability” of estate tax exemption. Portability is a provision that allows a surviving spouse to add any remaining federal estate tax exemption from the deceased spouse to their own. Here’s how it works.
If you’re preparing an estate plan, a financial advisor can help you understand key concepts to protect your assets.
How Portability in Estate Planning Works
Portability could effectively double the tax exemption that a surviving spouse can use, thereby reducing tax liabilities. It was introduced by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 and was made permanent by the American Taxpayer Relief Act of 2012.
For example, let’s take a couple where a spouse dies first and leaves behind an exemption of $5 million that was not used. The surviving spouse can add this $5 million to their exemption, thereby increasing the tax-free estate value. This can be an effective way to maximize the combined estate tax exemption.
Benefits and Limitations of Portability for Spouses in Estate Planning
Portability makes estate planning simpler and maximizes tax benefits. It allows couples to use their full estate tax exemption without relying on complicated strategies like credit shelter trusts. Many taxpayers believe incorrectly that portability could diminish the value of their estates. However, by utilizing the unused part of the estate tax exemption from a deceased spouse, the surviving spouse could also save on estate taxes and thereby preserve more of the estate for beneficiaries.
You should note, however, that portability also has limitations. Apart from applying only to federal estate taxes and not most state-imposed estate taxes, it’s important to understand that portability is not automatic. You must elect for it by the executor of the estate of the deceased spouse within five years of the date of death.
Key Points to Know About Portability
Here are key components that could change how you use the estate tax exemption. There are two main points to consider:
- The exempt amount is increased for inflation each year. This means that the total exemption for a married couple can potentially increases each year, providing a bit more tax relief over time.
- Portability is available only to surviving spouses. The deceased spouse must not have fully used their exemption at the time of death.
- Portability works with the gift tax. The unused exemption inherited by the surviving spouse can be used to make tax-free gifts in their lifetime, sheltering the estate from further taxes.
- To use portability, the executor of the deceased spouse’s estate must file a Form 706. The election must be made within 9 months of the date of death, although a 6-month extension can be requested. Even estates not subject to estate tax due to their small size must file this form to preserve portability.
Ultimately, you may want to consider talking to a professional before moving forward with the use of portability.
Utilizing Portability for Strategic Gifting
Strategic gifting is one effective application of portability. The concept is that the surviving spouse can make significant gifts during their lifetime by leveraging the deceased spouse’s unused exemption. This can result in the reduction of the taxable estate.
To clarify, a surviving spouse with an unused exemption of $5 million becomes able to gift up to this amount during their lifetime without incurring any gift tax. In doing so, this could allow you to transfer additional wealth to your beneficiaries tax-free.
Bottom Line
Understanding portability, its benefits, and its limitations is an essential component of effective estate planning. It’s a powerful tool that can maximize estate tax exemption benefits, minimize potential estate taxes and enable strategic gifting. It’s also a dynamic process requiring timely actions. Some actionable steps include being proactive in understanding your estate’s value, making decisions about portability early on and tracking inflation-adjusted exemption increases yearly.
Tips for Estate Planning
- Working with a financial advisor can simplify your estate planning process and help you make sure you’re setting up your estate correctly. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you’re just getting started, consider using an estate planning checklist to make sure you’re thinking about the right things.
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