September 3, 2024
Minimize a Surviving Spouse’s Estate Tax: The Benefits of the Portability Election
Article Highlights:
- United States Estate Tax Return
- Portability Election
- Purpose of the Portability Election
- Qualifications for Filing a Portability Election
- Special Portability Filing Rules
- Complications Associated with Preparing Form 706
- Who Should Make a Portability Election?
- Example When Portability Election is Not Made
- Importance of Signing a Refusal Letter
The Form 706, also known as the United States Estate (and Generation-Skipping Transfer) Tax Return, is a critical document in estate planning and tax management. One of its significant features is the portability election, which allows a surviving spouse to utilize their deceased spouse's unused estate tax exclusion amount. This article delves into the intricacies of the 706 portability election, including its purpose, qualifications, special filing rules, complications, and the importance of making an informed decision.
Form 706 is used to report the value of a decedent's estate and calculate the federal estate tax due. It is also used to compute the generation-skipping transfer (GST) tax. The form must be filed if the gross estate, plus adjusted taxable gifts and specific exemptions, exceeds the lifetime estate tax exclusion amount. For deaths in 2024, this exclusion amount is $13.610 million. The top tax rate is 40%. Form 706 is generally due no later than nine months from the decedent’s date of death, with a 6-month extension of time available, if applied for.
Purpose of the Portability Election: The portability election allows a surviving spouse to apply the deceased spouse's unused exclusion (DSUE) amount to their own transfers during life (i.e., gifts in excess of the annual gift tax exclusion amount to other individuals) or at death. This provision, introduced by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, aims to simplify estate planning for married couples and ensure that the estate tax exclusion is fully utilized.
Qualifications for Filing a Portability Election: To qualify for the portability election, the following conditions must be met:
- Decedent's Date of Death: The decedent must have died after December 31, 2010.
- Surviving Spouse: The decedent must have a surviving spouse.
- Citizenship or Residency: The decedent must have been a U.S. citizen or resident at the time of death.
- Estate Tax Return Requirement: The estate must not be required to file an estate tax return based on the value of the gross estate and adjusted taxable gifts, without regard to the need to file for portability purposes.
Special Portability Filing Rules: Special filing rules, referred to as the “simplified method” provide a means for obtaining an extension of time to file Form 706 beyond the normal filing deadline only to make a portability election. Under the current version of this simplified procedure, a complete and properly prepared Form 706 must be filed on or before the fifth anniversary of the decedent's death. Before this special rule became effective, when no 706 had been filed and the filing deadline had passed, a request had to be submitted to the IRS for a private letter ruling granting additional time to file the 706 so that the portability election could be made. The IRS charged a significant fee to process the request. Under the simplified method, no user fee is required.
Complications Associated with Preparing Form 706 - Preparing Form 706 can be complex and time-consuming. Some of the complications include:
- Valuation of Assets: Accurately valuing the decedent's assets, including real estate, investments, and personal property, can be challenging.
- Deductions and Credits: Identifying and calculating allowable deductions and credits, such as charitable contributions and marital deductions, require meticulous attention to detail.
- Documentation: Gathering and organizing the necessary documentation to support the reported values and deductions can be arduous.
Because of its complexity the cost of preparing a Form 706 can be substantial and often becomes a factor in whether to make the portability election.
Who Should Make a Portability Election? The portability election is particularly beneficial for surviving spouses who anticipate that their own estate may exceed the lifetime exclusion amount. By electing portability, the surviving spouse can substantially increase their exclusion amount, potentially saving thousands, if not millions, of dollars in estate taxes.
Even if the surviving spouse's estate is currently below the exclusion threshold, it is prudent to consider the portability election. Future changes in wealth, such as winning the lottery, receiving a sizable inheritance, or accumulating additional assets, could push the estate above the exclusion limit. Additionally, under current law the exclusion amount is set to be approximately halved after 2025. Whether the more generous amount will be extended is up to Congress.
Example: When Portability Election is Not Made - Consider a scenario where John dies in 2024, leaving an estate valued at $10 million. His wife, Jane, who is the executor of his estate, decides not to file Form 706 to elect portability, reasoning that her estate is well below the $13.610 million exclusion amount. However, a few years later, Jane inherits $5 million from a relative and her investments appreciate significantly, pushing her estate value to $15 million.
Without the portability election, and if the exclusion amount in her year of death was also $13.610 million, Jane's estate would only have the $13.610 million exclusion, resulting in a taxable estate of $1.39 million. At a 40% tax rate, her estate would owe $556,000 in estate taxes. Had she elected portability, she could have utilized John's unused exclusion, potentially saving her estate from any tax liability. Her heirs will wish that she’d made the election.
Importance of a Signing a Refusal Letter - If the decision is made not to file for the portability election, the tax preparer may request a signed refusal letter from the executor and surviving spouse. This letter serves as documentation that the tax preparer informed the client of the potential benefits and risks associated with the portability election. It also protects the tax preparer from potential liability if the surviving spouse's estate later incurs estate taxes that could have been avoided with the portability election.
This firm’s goal is to help you navigate the complexities of the tax code and maximize your tax benefits. If you have any questions or need assistance with your tax return, please do not hesitate to contact this office.
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