BY JOHN M. GORALKA
PUBLISHED APRIL 14, 2022
The federal estate tax exemption and gift exemption is presently $12.06 million. A married couple can transfer $24.12 million to their children or loved ones free of tax with proper planning. The exemption is tied to inflation, so it will continue to rise. Why should we be concerned about estate tax if our estate is less than $12.06 million?
If gridlock continues for legislation affecting taxation, then the exemption drops to approximately $6 million on Jan. 1, 2026 ($5.49 million indexed for inflation) under current law. Joe Biden’s presidential campaign included a proposal to further reduce the exemption to $3.5 million. No one knows what the long-term future may bring.
How Married Couples Can Lose a $12.06 Estate Tax Exemption
In the event of a death, we should consider taking advantage of the current $12.06 million estate tax exemption. Note that this exemption is a “use it or lose it” planning alternative. Without proper planning, a married couple can, and often does, lose one of the two lifetime exemptions available to them.
For most families, an overall estate plan will leave all or a substantial amount for the surviving spouse. Assets left to a surviving spouse qualify for an “unlimited marital deduction.” The terms “unlimited” and “deduction” would seem to be a good thing. However, this can trigger higher taxes. How? If there is no taxable estate on the death of the first spouse because all assets go to the surviving spouse and qualify for the martial deduction, then the deceased spouse’s unused exemption is, in effect, lost. The family’s available estate tax exemption was effectively reduced from $24.12 million to $12.06 million due to poor planning.
A $1.6 Million Estate Tax Bill Could Have Been Avoided
Existing law provides a tool to prevent the loss of an estate tax exemption as described above. The law allows a deceased spouse to transfer any unused portion of his or her exemption to their surviving spouse. This tool is referred to generally as “portability.” Sadly, many families are unaware of this opportunity and fail to take advantage of this important tool or planning alternative.
For example, let’s consider a family (husband, wife, kids) with a $10 million estate that is community property. That is, one-half is owned by each spouse. If the husband dies today, your initial thought is that they don’t have to worry about estate tax. There is a $12.06 million exemption for the husband and another $12.06 million for the wife. That is a combined exemption of $24.12 million. The estate is only $10 million.
However, if the wife lives to at least Jan. 1, 2026, (and we all hope that she does), then the family may eventually be looking at an estate tax bill of $1.6 million. How can that be with a $10 million estate? Well, the estate tax exemption fell to approximately $6 million on Jan. 1, 2026. If the wife held an estate worth $10 million (without regard to future appreciation), the taxable estate after the exemption is $4 million. With an estate tax rate of 40%, that triggers an estate tax liability in the amount of $1.6 million.
This $1.6 million must be paid in full in cash nine months from the date of the wife’s death, with certain regular limited exceptions. This may trigger the need to sell assets to pay the tax. Such a sale may result in a lower sale price. This is without regard to any future appreciation in the assets from his death in 2022 to the wife’s death in 2026.
How the Portability Election Can Help
In order to prevent the loss of husband’s $12.06 million exemption, a portability election must be made on a timely filed estate tax return for his death. This filing “ports” or transfers the husband’s entire lifetime exemption of $12.06 million to the wife’s estate. The family just saved $1.6 million in estate tax that would otherwise be due.
The only “downside” to filing for the portability election is the cost of filing the required return (IRS Form 706) estate tax. A portability-only estate tax return can be filed up to two years from the date of death. (For more information, please read IRS publication Rev. Proc. 2017-34.) Note that the valuation rules are relaxed for the filing of an estate tax return solely for the sale of portability. In particular, formal appraisals are not required for a portability-only tax return. Appraisals of business interests and real property can be expensive, so this will help reduce the cost for that filing significantly.
Nevertheless, there is a cost to the filing. A fee of $3,500 and up may provide a good benchmark, but it will typically rise in relation to the value and complexity of the estate and the number and type of assets held.
With the potential for a reduction in the estate tax exemption, a portability election may be considered as a form of insurance to protect the family from an unexpected estate tax liability. Consideration should be given upon the death of a married person with a total estate of $2 million or $3 million. Even married couples with an estate of $2 million or more may wish to file. The appropriateness for filing may depend upon their age, the likelihood of inheriting or earning significant assets or concern that the exemption may be further reduced in future years.
Consideration should also be made to provide for portability elections in pre- and post-marital agreements. In the event of a divorce or separation, even a well-crafted and well-thought-out estate plan may still trigger an estate tax liability. A provision providing the right to make a portability election in the event of a marital separation may be of substantial benefit to the surviving spouse.
