The Portability of the Estate Tax Exemption

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Paul Sundin, CPA

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Back in 2010, the estate planning world was first introduced to the concept of portability. This critical estate planning tool is now used by estate planning professionals all the time to increase the estate tax exemption.

What is Portability?

Portability is a planning tool available only to married couples. It essentially allows a surviving spouse to take the remaining estate tax exemption that the deceased spouse’s estate did not use. It is transferred to the surviving spouse to reduce the overall estate tax once the second spouse passes away. 

Thanks to portability, the surviving spouse can use the deceased spouse’s unused estate tax exemption and add it to their own when the surviving spouse passes away. 

Portability is a federal exemption. While most states don’t have an estate tax, some do. Hawaii and Maryland are two of the few states that allow portability of their state estate tax exemption.

How does the Federal Estate Tax Exemption work?

As of 2021, the federal estate tax exemption is $11.4 million. The exemption is, in fact, indexed annually for inflation, so it does increase over time.  

The exemption is subtracted from the value of estate assets, with the result being subject to the estate tax. In reality, very few estates will pay estate tax. 

Portability will hopefully remain a permanent part of federal estate tax law in the future. However, Congress may repeal this provision at any point. 

Portability Examples

The option of portability will make a significant difference. Let’s look at a few examples:

The Estate Tax With no Portability

Assume Phil and Dora are married and all of their assets are jointly titled. Their net worth is $20 million. Phil passes away first when the federal estate tax exemption is $11.4 million. Sue did not make a portability election.

Phil’s estate does not need to use any of his $11.4 estate tax exemption when Phil dies because all the assets are jointly titled. The unlimited marital deduction allows Phil’s share of the joint assets to be automatically transferred to Dora by right of survivorship without accruing any estate tax liability.

Lets’s assume the estate tax exemption is still $11.4 million when Dora dies. Thus, the estate tax rate is 40%, and Dora’s estate is still worth $20 million.

Phil’s $11.58 million estate tax exemption was unused, and Dora cannot claim the exemption without portability, so Dora can only use her exemption of $11.58 million when she passes away. Dora’s estate will owe about $1________ in estate taxes upon her death:

  • $20,000,000 estate less the $11.58 million exemption = $7.45 million taxable estate
  • $6.16 million taxable estate x 40% estate tax rate = $2.568 million in taxes due

The Estate Tax Example With Portability

Let’s take another look at the example above. Phil and Dora are married, and all of their assets are jointly owned. Their combined net worth is $20 million. Phil passes away first when the federal estate tax exemption is $11.45 million. The law at the time allowed for the portability of the estate tax exemption between a married couple. So when Dora passes away, the analysis is as follows:

  • $20 million total estate less $23.18 million with two estate tax exemptions results in no estate tax liability

Phil’s estate does not have to use any tax exemption because all assets are jointly titled. As such, they will pass directly to Sue by right of survivorship. 

Let’s assume that the federal estate tax exemption is still $11.64 million when Dora later passes away. As a result, the estate tax rate is 40%, and Dora’s estate is worth $17 million.

Phil’s unused $11.45 million estate tax exemption would be added to Dora’s exemption of the same amount with portability. This gives Dora a $24.67 million exemption when both exemptions are added together.

Essentially, Dora inherited Phil’s unused exemption, and she is then able to pass on her $18 million in assets free from estate tax at her date of death. 

As a result, the portability of the estate tax exemption will save Phil and Dora’s beneficiaries about $2.9 million in estate taxes.

How to make the Portability election

Dora will not automatically receive Phil’s remaining unused exemption. Instead, she must file IRS Form 706, the United States Estate, and Generation-Skipping ​Transfer tax return when Bob passes away to make the election to add his remaining unused exemption to her exemption.

US tax law imposes a tax on a taxable estate that exceeds $11.49 million. But the exclusion amount is actually portable between two married spouses. What the means is that if any portion goes unused when the first spouse passes away, the unused portion is allowed to be added to the exclusion amount that is available for the surviving spouse. However, a timely election must be made.

When a person passes away, their estate must file a US estate tax return within nine months of his or her death. This could be extended to 15 months if a tax extension was timely filed. The estate can elect to apply the unused deceased spouse’s exclusion (called the “DSUE”) to the spouse.

As a general rule, failing to timely file an estate tax return means that the DSUE is not portable to the surviving spouse. Moreover, with estate tax rates at 40%, non-filing of the estate tax return can create a significant estate tax liability. 

But there is some relief. For example, suppose an estate was not otherwise required to file an estate tax return because the decedent’s estate did not exceed the statutory applicable exclusion amount. In that case, the IRS has procedures in place.

The rules allow the IRS to grant an extension of time to file the estate return and make the portability election. Under this scenario, the IRS states that an extension of time can be requested by using the procedures of regulation section 301.9100-3.

The IRS will grant relief if the estate demonstrates that it acted in good faith and that the relief would not prejudice the interests of the US government. 

As a result, if the estate would have filed a return only to elect portability but failed to file within nine months of death (15 months including an extension), the procedures allow the estate to complete a letter ruling request for additional time to file the return and make the portability election. However, the extension will be denied if the decedent’s assets (plus taxable gifts) exceed the applicable exclusion amount.

Estate tax portability has been around only recently, so many questions have arisen. As such, the IRS has been swamped with letter ruling requests that have typically requested more time to make the election. 

The IRS has subsequently issued Revenue procedure 2017-34, that supersedes prior regulations and sets forth a new process to obtain a late portability election if the decedent was not otherwise required to file an estate tax return because their gross estate (in addition to any taxable gifts) does not exceed the applicable exclusion amount. 

The specified procedure states that a late portability election can be made by simply filing an estate tax return that is marked as “FILED PURSUANT TO REV. PROC. 2017-34 TO ELECT PORTABILITY UNDER §2010(c)(5)(A).” 

The procedure grants automatic late election relief to any tax return filed as long as the decedent’s estate does not exceed the applicable exclusion and that the return was filed within two years subsequent to the decedent’s death.

The IRS will often consider private letter ruling requests if relief under this new Revenue procedure is unavailable. If the estate return was not filed before the later of two years after the decedent’s death.

There may be drastic changes coming to US estate tax soon. Legal, tax, and financial advisors should plan for these changes by review client’s estates. A client should consider making a portability election when a decedent was married at the date of death.

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Gilbert, AZ