The concept of portability relates to the carryover of the estate tax exemption from the first spouse to die (“predeceased spouse”) to his or her surviving spouse. After someone dies, portability essentially allows the estate of a predeceased spouse to elect to transfer the predeceased spouse’s unused exemption amount to the surviving spouse. It is referred to as the surviving spouse’s “deceased spouse unused exclusion” (“DSUE”)1. In effect, the deceased spouse’s unused estate tax exemption is effectively added to the surviving spouse’s exemption. The surviving spouse can use the DSUE amount against any tax liability resulting from inter vivos gifts (those made during the surviving spouse’s lifetime) or transfers at death.
Portability was first introduced by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRA 2010) and made permanent by the American Taxpayer Relief Act of 2012 (ATRA), P.L. 112-240. The reform is considered “permanent” because there is no sunset provision in the law that would cause the current rules to expire. With that said, a “permanent” change does not mean the law will never change but rather means it is effective until the next change.
In 2019, Maryland’s estate tax exemption is set to “recouple with” (i.e., match) the federal estate tax exemption amount. At that time, Maryland portability will also be available to residents of the state. It is presumed that D.C. will also take steps to recouple with the federal estate tax. Yet as of July 1, 2016, no date for such action has been identified. Virginia, on the other hand, has no state estate tax.
First and foremost, portability is not automatic. To elect portability, an estate tax return (Form 706) must be timely filed on the death of the predeceasing spouse even if no estate tax is due and even if no estate tax return is otherwise required to be filed.2
Failure to timely file may prevent the estate from making a portability election. However, if the estate is not required to file an estate tax return, it can submit to the IRS a request for a private letter ruling granting an extension of time to make the portability election under § 301.9100-3 of the Treasury Regulations.
Regardless of whether a predeceasing spouse’s estate is well above or well below the exemption threshold, making the portability election by filing Form 706 at the time of the predeceasing spouse’s death will avoid later regret at failing to do so if circumstances change (e.g., decrease in the exemption amount, the surviving spouse wins the lottery or otherwise gains significant assets). Generally, the cost to file just for portability is relatively minimal, and if a MET-1 (Maryland Estate Tax Return) is required to be filed, then a Form 706 will have to be prepared to complete the MET-1 anyway. D.C. also requires that a Form 706 be attached to the D.C. D-76 estate tax return.
There is a special rule for estates that are not otherwise required to file an estate tax return. If filing just for portability, generally the estate does not need to report the value of certain property that qualifies for the marital or charitable deduction. Instead, the estate needs only to report the description, ownership and/or beneficiary of such property, along with all other information necessary to establish the applicable deduction.3
Portability is only available with respect to the estate tax exemption amount of the "last deceased spouse."4 If the surviving spouse remarries, the deceased spouse's DSUE amount may be lost if the surviving spouse’s new spouse predeceases the surviving spouse. To avoid losing the first deceased spouse’s DSUE amount, it may be beneficial to have the surviving spouse gift certain assets shortly after the predeceasing spouse’s death. When a surviving spouse makes a taxable gift, he or she will use any DSUE amount available before his or her own gift tax exemption. Thus, in some circumstances, a surviving spouse must “use it or lose it” with regard to the DSUE amount.
For years, the foundation of a married couple’s estate plan was primarily based on the “A-B Trust” approach. Under this approach, upon the death of the first spouse, his/her assets were automatically divided and administered in two separate trusts, referred to as an “A Trust” and a “B Trust,” the former being a Marital Trust and the latter being the “Bypass Trust” or “Credit Shelter Trust.” The idea is to capture the estate tax exemption amount of the first spouse to die in trust, rather than leaving all of the assets to the surviving spouse outright. This avoided wasting the opportunity to shelter some of the couple’s assets at the first spouse’s death from estate tax it would face at the surviving spouse’s later death.
When the surviving spouse subsequently dies, the balance of the trust assets in the “B Trust” (or the “Bypass Trust”) pass free of estate tax to the remainder beneficiaries. In short, the traditional A-B trust plan utilizes both spouses’ exemption amounts and defers any estate tax that otherwise would be due until the subsequent death of the surviving spouse.
Portability introduces alternatives to traditional estate planning, especially the common “A-B Trust” approach for married couples. However, Portability does not completely eliminate the need for a Bypass Trust and/or Marital Trust. A more customized approach may be needed, especially when confronted with the following situations: