Portability: Maximizing the Use of Estate Tax Exemptions

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Portability: Maximizing the Use of Estate Tax Exemptions

Oct 27, 2016

by Gregory S. Dowell

An important change in the area of estate taxes occurred when “portability” elections came into play. The estate tax exclusion allows an individual to exclude a certain amount of his or her estate ($5.45 million in 2016) from federal estate taxes at death. For many years, it was necessary to plan to balance the ownership of assets between spouses so that each spouse, upon death, might take full advantage and maximize the exclusion from federal estate taxes. If the estate of a deceased spouse, through lack of planning or error, was unable to use part of the estate tax exclusion because too few assets had been transferred to the deceased spouse, there was no way to take corrective action. The surviving spouse simply would be left with a potentially taxable estate at death, solely because of the failure to balance the holdings to maximize the estate tax exclusions of the spouses.

Portability allows a taxpayer to elect to transfer at death any unused exclusion amount to the surviving spouse. The amount received by the surviving spouse is called the deceased spousal unused exclusion (“DSUE”). In this way, the estate tax exclusion that was not used by the deceased spouse became portable and was transferred to the surviving spouse for his or her use in the future. To gain this benefit, the executor of the decedent’s estate must specifically elect portability of the DSUE. If the election is made, the surviving spouse can apply the DSUE received from the estate of his or her last deceased spouse against any estate tax liability arising from subsequent lifetime gifts and transfers at death. Assuming the election is made, the applicable exclusion amount that remains unused as of the death of the first spouse to die is generally added to the basic exclusion amount of the surviving spouse. Again, the exclusion amount is $5.45 million for 2016. Even though the exclusion amount is adjusted annually for inflation, the DSUE amount of the deceased is determined as of the year of death of the first spouse to die, and is not adjusted for inflation that occurs after that spouse dies.

Recall the underline above regarding the last deceased spouse. For this purpose, the last deceased spouse is the most recently deceased person who was married to the surviving spouse at the time of that person’s death. The identity of the last deceased spouse is determined as of the day a taxable gift is made, or in the case of a transfer at death, the date of the surviving spouse’s death. If the surviving spouse remarries, it does not affect the designation of the last deceased spouse and does not prevent the surviving spouse from applying the DSUE amount to taxable transfers.

To elect portability of the DSUE the executor must timely file an estate tax return on form 706. The filing requirement applies to all estates of decedents choosing to elect portability, regardless of the size of the estate. As a result, an estate that would normally not have to file an estate tax return because the estate is less than the estate exclusion amount that is applicable in the year of death must file a return to elect portability. Taxpayers can also opt out of portability on a timely and completely filed estate tax return.

An outcome of portability is that estate tax returns will be filed more often (remember that portability must be elected by filing an estate tax return for the deceased), and will be filed in cases where the estate value is below the threshold that would require filing. While it will be obvious in some cases that an estate tax return should be filed, in some cases an executor will need to be aware and consider filing the estate tax return in order to elect portability, even when the return is not required to be filed. For instance, in those cases where the assets were imbalanced between the spouses, it may be prudent to file and elect portability.

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by Gregory S. Dowell Updated May 16, 2023 Spring is the traditional kick-off to wedding season, and thoughts quickly turn to the wedding venue, gifts, the happy couple, and, of course, the guest list. Lurking somewhere in the shadows, behind even that strange uncle you barely know, is another guest that needs to be considered: The tax impact on the newlyweds. To start, newlyweds will have two options for filing their income taxes in the year of marriage: Filing status can either be married filing jointly, or married filing separately. In the vast majority of cases, a couple will benefit with a lower overall tax burden to the couple by choosing to file married filing jointly. One of the classic cases where a couple may consider filing separately is when one spouse has significant amounts of medical expenses for the year. Medical expenses are only deductible if they exceed 7.5% of adjusted gross income; using only one spouse's income may allow a deduction to be taken if filing separately, compared to losing the medical deduction entirely if both incomes are combined by filing jointly. We previously had written about the tax trap that often occurs when two people get married, resulting often in an unanticipated balance due when the first joint tax return for the couple was filed. While President Trump’s Tax Cuts and Jobs Act (TCJA), changed the dynamics somewhat, it is still worthwhile to put pen to paper before saying “I do”. Prospective spouses have the opportunity to save money by taking income tax considerations into account before tying the knot. That’s particularly true for those who plan to marry late this year or early next year. As this article explains, from the federal income tax standpoint, some individuals marrying next year may come out ahead by either deferring or accelerating income, depending on their circumstances. Others may find it to their advantage to defer a year-end marriage until next year. For some quick background, a “marriage penalty” exists whenever the tax on a couple’s joint return is more than the combined taxes each spouse would pay if they weren’t married and each filed a single or head of household income tax return. Before President Trump’s TCJA, only the 10% and 15% married filing jointly brackets were set at twice that of the singles bracket, and so the marriage penalty effect on joint filers applied in the brackets above the 15% bracket. Beginning with the 2018 tax year, however, the TCJA set the statutory tax brackets for marrieds filing jointly-through the 32% bracket-at twice the amount of the corresponding tax brackets for singles. As a result, the TCJA eliminated any tax-bracket-generated marriage penalty effect for joint filers where each spouse has roughly the same amount of taxable income-through the 32% bracket. For example, if two individuals who each have $215,950 of taxable income file as single taxpayers for 2022, each would have a tax bill of $49,335.50, for a combined total of $98,671. If they were married, their tax bill as marrieds filing jointly would be $98,671, exactly the same amount as the combined total tax they’d pay as single taxpayers. Because the 35% bracket for marrieds filing jointly isn’t twice the amount of the singles 35% bracket, the marriage penalty effect will still apply to joint filers whose income falls in the 35% bracket. Using 2022 tax tables, two single taxpayers may each have $500,000 in taxable income, for a combined total of $1,000,000, without having any of it taxed higher than 35%. However, for marrieds filing jointly, the 35% tax bracket ends at $647,850 in taxable income, and each additional dollar of taxable income taxed at 37%. Thus, where two high-earning unmarried taxpayers with substantially equal amounts of taxable income are planning for their marriage to take place either late this year or early next, it may pay from the tax viewpoint to defer the marriage until next year. As an example, if two individuals each have $539,900 of taxable income file as single taxpayers for 2023, each would have a tax bill of $162,718, for a combined total of $325,436. If they were married before the end of the year, their tax bill as marrieds filing jointly would be $334,076, or $8,640 more than the combined total tax they’d pay as single taxpayers. If only one of the prospective spouses has substantial income, marriage and the filing of a joint return may save taxes, thus resulting in a marriage bonus. The bonus is the result of two factors: 1) the tax brackets for marrieds filing jointly cover wider spans of income than the tax brackets for taxpayers as singles; and 2) the taxable income of the lower-earning individual may not push the couple’s combined income into a higher tax bracket. In such a case, it will probably be better from the tax standpoint to accelerate the marriage into this year if feasible. There are a number of other factors that should also be taken into account when determining the effect of a marriage on income taxes of the couple. As mentioned early in this post, the first decision is to verify that filing a joint return is preferred to filing separate returns. In addition, many provisions of the tax code phase out completely (or decrease partially) as adjusted gross income increases. In a perfect world, there would only be good surprises for a newlywed couple following their wedding. To avoid any unpleasant income tax surprises, we always recommend that a newlywed couple take the time to make a projection of what their income will look like when combined as a couple, and determine what the tax bill will look like, at the Federal and State levels. After all, planning ahead, communicating with each other, discussing finances, and avoiding unpleasant surprises are some of the keys to a long marriage.