Portability is one of the most important concepts in estate planning. In this post, we will look at the sections of Form 706 that relate to Portability and even look at a sample 706 for portability. We will also look at a simplified election example.
Since it came into law back in 2010, it has altered many estate planning strategies and reduced the need for Bypass trusts and credit shelter trusts. Let’s get started.
Table of contents
- What is Portability?
- Why elect Portability?
- Simplified Sample 706 for Portability
- IRS Audit of Portability
- What about Portability at the state level?
- Election Example Only
What is Portability?
In theory, Portability is a simple concept. It allows the unused or remaining portion of the deceased spouse’s exclusion to be added to the surviving spouse’s exclusion. The remaining amount is often called the deceased spousal unused exclusion (or “DSUE”).
The executor must file Form 706 within nine months of the date of death. A six month extension is allowed. But if Form 706 is filed to elect portability only, the executor can file anytime prior to the second anniversary of decedent’s date of death.
The simplified election is to be made by the executor of the deceased spouse’s estate. Form 706 is required to be filed to make the election. In addition, even estates that would not otherwise have to file an estate return (usually because the estate size is too low) must file Form 706 to make the required election.
An executor is not required to report a value for property deductible as a marital deduction or charitable deduction property.
The executor is still required to report and list the property description, ownership, and beneficiary. The executor is required must provide all other information necessary to establish the estate’s right to the deduction.
This rule does not apply if the property’s value impacts or is required to calculate the value passing from the decedent directly to the recipient.
Why elect Portability?
The IRS has recently revised the instructions to Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. They provided guidance for electing Portability. The instructions also cover the executor’s ability to use a checkbox to opt-out of electing Portability of the unused exclusion amount.
When Portability only is elected, you are required to:
1) Inform the IRS if any assets are being transferred to a QDOT (Qualifying Domestic Trust);
2) Calculate the DSUE amount; and
3) Report any DSUE amount received from the predeceased spouse.
Simplified Sample 706 for Portability
I will now go through each section of Form 706 that addresses Portability. I will also include images from the form itself so you can familiarize yourself with the contents of the Form. It can get intimidating, but I will try to simplify.
Portability of Deceased Spousal Unused Exclusion (DSUE) is addressed on page 4, Part 6 of Form 706. The section itself is not very long. The following is the introductory part of the section:
Section A: Opting Out of Portability
Check the box in this section to elect out of Portability. If checking the box in this section, you don’t need to complete sections B and C.
So you might be asking: why would you want to elect out of portability?
In most situations, this would be a mistake. However, it can make sense to opt out of portability in the following situations:
- The unused exclusion amount is not indexed for inflation when it is then transferred to a surviving spouse.
- A credit shelter trust can offer more creditor protection.
- A credit shelter trust allows assets to appreciate freely outside of the estate.
- The “last deceased spouse” rule means that a spouse is only entitled to the exclusion of the last deceased spouse (regardless of the dollar amount).
Section B: QDOT
When working on estate returns, an essential question for legal and tax professionals is the citizenship and residency of both the decedent and the surviving spouse.
If the deceased person had a spouse that isn’t a U.S. citizen, the estate could transfer assets to a qualified domestic trust (QDOT). If this occurred, then check yes. If not, then check no. If you checked yes, then the DSUE calculation is considered preliminary until there’s a subsequent taxable event.
An executor who intends to elect Portability must complete Section B of Part 6 if any of the estate’s assets are transferred to a qualified domestic trust (QDOT).
Section C: DSUE for Surviving Spouse
Now we get to the meat of the election – the actual calculation itself. Section C is used to calculate the deceased spouse’s unused exclusion amount. This section is only completed if portability is elected. The amount that is portable to the surviving spouse is the lower of the exclusion amount in place on the date of death (whose DSUE is being computed) or the decedent’s applicable exclusion reduced by the amount on line 5 of Part 2 – Tax Computation on Page 1 of Form 706.
Exclude amounts on which gift taxes were paid in doing this computation.
Estate executors are not required to file Form 706 if the gross estate value (including previous taxable gifts made) is below the standard exclusion amount. However, IRS rules allow executors who are filing solely to elect simplified portability of the decedent’s DSUEA to the surviving spouse do not have to report the value of certain property that is eligible for either the marital deduction or the charitable deduction.
The asset values must be estimated and included in the total value of the gross estate. The assets can be rounded down to the nearest $250,000, but are not required to be listed on the recapitulation provided in Form 706, Part 5.
Section D: DSUE Amount Received from Predeceased Spouse(s)
Report any DSUE amount received from the decedent’s last deceased spouse and previously deceased spouses. Unused amounts from previously deceased spouses can’t be used on this return, but amounts used previously in making gifts must be reported here.
The remaining DSUE amount from the last deceased spouse is carried forward to Line 9B of Part 2 – Tax Computation on Page 1 of Form 706. Take a look at the election example.
If the executor files Form 706 solely for Portability purposes, Form 8971 (Information Regarding Beneficiaries Acquiring Property from a Decedent) does not need to be filed.
IRS Audit of Portability
It is critical to note that there is no statute of limitations on the number of years the IRS can go back to audit and correct a DSUE reported by the estate of the spouse who died first.
This increases the importance of retaining the first spouse’s 706 and the underlying documents supporting the DSUE calculation. The executor especially wants to get appraisals for hard-to-value assets.
What about Portability at the state level?
If you have to file a state inheritance tax return, check that state’s laws regarding the DSUE.
How to File 706 for Portability:
- Discuss portability pros and cons with surviving spouse
While electing portability makes a lot of sense for most surviving spouses, there are some important downsides to consider. Make sure that the pros and cons are carefully examined and that everybody is on the same page.
- Obtain estate asset valuations and review for accuracy
Make sure to review the estate assets and ensure that the assets listing is accurate and complete.
- Complete all sections of Form 706 Part 6
These sections will cover QDOTs, portability from prior spouses and the actual calculation itself.
- Consider state portability options
Most states do not have an estate tax and only a couple allow for portability. This should only be addressed to ensure that state estate tax returns are filed if applicable.
- Review Form 706 with estate attorney
I always like to review the Form 706 with the estate attorney to make sure that nothing is missed. It is a good chance to review a simplified election example.
Election Example Only
If the estate is not otherwise required to file an estate tax return, not filing Form 706 will prevent the election from being made. Only the appointed executor acting on behalf of the decedent’s estate can make or opt out of the election.
Remember that filing Form 706 itself effectively makes the election. Form 706 provides a procedure for estates required to file because the gross estate’s value exceeds the corresponding exclusion amount or for another reason to opt-out of the election.
But be careful. Once the portability election is made, it is irrevocable. Technically, the executor of the estate makes the election and not the surviving spouse.
Thanks to our simplified election example, you should now have a good understanding of how Portability works!