When an individual leaves behind property to beneficiaries, this property is subject to an estate tax if its total value exceeds the federal estate tax exclusion amount. As of 2014, the estate tax exclusion amount is $5.34 million.
However, under the 2013 American Taxpayer Relief Act, a married individual can transfer his or her unused estate tax exclusion amount to their surviving spouse. This newly permanent feature of the law—referred to as “portability”—can be used to your benefit when estate planning with your spouse.
How Does Portability Work?
If a spouse passes away, and the value of their estate doesn’t use up all of their exemption from estate taxes, the amount that wasn’t used can be passed on to the remaining spouse. This means that he or she can combine the deceased partner’s unused exemption with their own exemption when the surviving spouse passes on in the future. This results in a married couple ending up with an overall exemption of two times the individual amount.
You can think of it in terms of this equation:
The aggregate deceased spousal unused exemption amount + the surviving spouse’s exemption amount = total exemption amount available.
Confused? Let’s take a look at an example.
Henry and Mary are a happily married couple. Henry has $3 million in assets, while Mary has $5 million in assets. When Henry dies, he leaves behind his $3 million in assets to Mary. Because they are a married couple, Henry doesn’t have to pay estate tax on this amount. When Mary dies, she leaves her family with her own $5 million combined with Henry’s $3 million—$8 million in total. Even though this value of the estate exceeds the exemption amount, Mary doesn’t have to pay any estate tax, since she can use some of Henry’s leftover exemption.
With portability, you may be able to avoid paying costly taxes to the government on your estate. In the past, it was necessary to create special trust—often called a “family trust” or “credit shelter trust”— for surviving spouses to avoid such taxes. Portability can simplify the process of planning your estate, since it allows the entire amount of you and your spouse’s individual exemptions to be used without the expensive and complex process of creating a trust.
Potential Problems with Portability
However, there are certain important considerations to keep in mind before deciding to rely exclusively on portability to ensure optimal estate tax exemption for you and your spouse. Here are a few of them:
Remarriage. Using portability can become tricky if a spouse remarries. If a surviving spouse is predeceased by two or more partners, the amount of unused exemption they can apply to their own estate is limited to the lesser of the unused exclusion of the most recently deceased spouse or $5.34 million.
Inflation. With portability, all of a couple’s assets will pass to the surviving spouse, as well as the deceased spouse’s unused exemption. However, the unused exemption is not indexed for inflation.
No asset protection. While a trust would offer some asset protection for the estate, portability provides no asset protection, since the surviving spouse takes on full ownership of these assets.
Constantly changing estate tax laws. Estate tax laws are constantly changing, so there is a possibility that exemption amounts and portability may not be still in effect at the time of you or your spouse’s death.
Deciding Between Portability and a Trust
So which is better? Creating a special trust to protect your estate from costly taxes, or relying on portability? The answer depends on your unique estate and situation. When deciding on the best estate plan for you, consider these factors.
The value of your estate. How much is your estate worth? If the combined value of you and your spouse’s assets is less than $5.34 million, you won’t owe any estate tax. The vast majority of estates in the U.S. will not end up owing federal tax.
Anticipated change in the value of assets. If your estate is valued at less than $5.34, could it increase in value by the time of you or your spouse’s death?
Likelihood of remarriage. What is the probable length of time that will pass between you and your spouse’s death? Considering this, is there a possibility one of you may want to remarry?
Additional taxes. Are there any additional taxes to which your estate may be subject, such as capital gains or income taxes?
If you are trying to determine if using portability is a suitable plan for your estate, it would be wise to contact an experienced estate planning attorney. A skilled and knowledgeable lawyer can help you understand the pros and cons of various planning strategies, and help you navigate the complicated process of filing the necessary estate tax return if you do decide that portability is right for you.
About the Author:
Christopher Q. Wintter is the founder of Wintter & Associates, P.A. and a board-certified expert in Trust and Estate matters by the Florida Bar. With more than 24 years’ experience as a practicing attorney, he also serves as an instructor and faculty member for the National Institute of Trial Advocacy (NITA)—the nation’s leading provider of legal advocacy skills training to practicing attorneys—and has earned the AV® Preeminent™ rating with LexisNexis Martindale Hubbell. He was also selected for inclusion in Florida Super Lawyers for 2011 and 2012 in Estate and Trust Litigation.