Portability of the Estate Tax Exemption: How it Happens

Attorney Christine S. Anderson

December 2015

A limited amount of a person's wealth can be transferred to his or her loved-ones free from gift, estate and generation skipping transfer tax. Currently, the amount exempt from gift, estate and generation skipping transfer tax is $5,430,000 per person. In 2016, it increases to $5,450,000 per person.

Before 2010, the exemption had to be used by transfers occurring either during lifetime or at death. 'œUse it or lose it' was the rule. For example, if a wife died in 2009 and left her entire estate to her U.S. citizen spouse, there would be no estate tax upon her death, because of the unlimited marital deduction for transfers to a U.S. citizen spouse. When the husband later dies, he would only have one estate tax exemption to shelter his estate from tax. The wife in this example wasted her estate tax exemption by leaving her entire estate to her husband.

When Congress passed The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 'œ2010 Tax Act') the use it or lose it rule with respect to the gift and estate tax exemption changed dramatically. The concept of portability of a person's unused gift and estate tax exemption became law. The 2010 Tax Act provided that a person could use the gift and estate tax exemption not used by his or her deceased spouse, in addition to his or her own exemption. In January of 2013, The American Taxpayer Relief Act of 2012 became law and made the portability provisions permanent.

In prior articles and annual letters, we have encouraged clients to consider simplifying their estate plans as a result of the portability of the gift and estate tax exemption and the increased exemption. It is important to understand the mechanics of how the unused exemption of a deceased spouse is transferred to the surviving spouse. It does not happen automatically.

In order to transfer the unused estate tax exemption from a deceased spouse to the surviving spouse, an estate tax return must be filed within nine months of the death of the spouse. It is possible to get a six month extension for filing the estate tax return. The estate tax return must be filed even if the estate of the deceased spouse is less than the estate tax exemption and a return would not otherwise need to be filed. An estate tax return includes a comprehensive list of all assets owned by the decedent, which are valued as of the decedent's date of death.

For example, if Jane Jones dies in 2015 and she leaves $1,000,000 worth of life insurance to the children of her first marriage and the balance of her estate (an IRA worth $800,000 and the primary residence valued at $500,000) to her second husband, John Jones, John will be able to take advantage of the portability provisions of the estate tax law. Provided that John, as Executor of Jane's Estate and Trustee of her Trust, files an estate tax return, he can transfer Jane's unused estate tax exemption of $4,430,000 to himself ($5,430,000 minus the $1,000,000 exemption used on the life insurance passing to Jane's children.) The assets that Jane left to John qualify for the unlimited marital deduction and do not use any of Jane's estate tax exemption. After filing the return, John will have his own exemption of $5,430,000 plus Jane's unused exemption of $4,430,000 for a total of $9,860,000. John can use the exemption to shelter lifetime gifts or transfers at death.

The portability provisions do not apply to the generation skipping transfer tax exemption, however. For individuals who intend to maximize the amount exempt from the generation skipping transfer tax, it would be advisable to maintain assets in each spouse's separate trust. The first spouse to die would keep assets in his or her trust for the benefit of his or her spouse, children and grandchildren, if generation skipping transfer tax planning is a priority.

A limited amount of a person's wealth can be transferred to his or her loved-ones free from gift, estate and generation skipping transfer tax. Currently, the amount exempt from gift, estate and generation skipping transfer tax is $5,430,000 per person. In 2016, it increases to $5,450,000 per person.

Before 2010, the exemption had to be used by transfers occurring either during lifetime or at death. 'œUse it or lose it' was the rule. For example, if a wife died in 2009 and left her entire estate to her U.S. citizen spouse, there would be no estate tax upon her death, because of the unlimited marital deduction for transfers to a U.S. citizen spouse. When the husband later dies, he would only have one estate tax exemption to shelter his estate from tax. The wife in this example wasted her estate tax exemption by leaving her entire estate to her husband.

When Congress passed The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 'œ2010 Tax Act') the use it or lose it rule with respect to the gift and estate tax exemption changed dramatically. The concept of portability of a person's unused gift and estate tax exemption became law. The 2010 Tax Act provided that a person could use the gift and estate tax exemption not used by his or her deceased spouse, in addition to his or her own exemption. In January of 2013, The American Taxpayer Relief Act of 2012 became law and made the portability provisions permanent.

In prior articles and annual letters, we have encouraged clients to consider simplifying their estate plans as a result of the portability of the gift and estate tax exemption and the increased exemption. It is important to understand the mechanics of how the unused exemption of a deceased spouse is transferred to the surviving spouse. It does not happen automatically.

In order to transfer the unused estate tax exemption from a deceased spouse to the surviving spouse, an estate tax return must be filed within nine months of the death of the spouse. It is possible to get a six month extension for filing the estate tax return. The estate tax return must be filed even if the estate of the deceased spouse is less than the estate tax exemption and a return would not otherwise need to be filed. An estate tax return includes a comprehensive list of all assets owned by the decedent, which are valued as of the decedent's date of death.

For example, if Jane Jones dies in 2015 and she leaves $1,000,000 worth of life insurance to the children of her first marriage and the balance of her estate (an IRA worth $800,000 and the primary residence valued at $500,000) to her second husband, John Jones, John will be able to take advantage of the portability provisions of the estate tax law. Provided that John, as Executor of Jane's Estate and Trustee of her Trust, files an estate tax return, he can transfer Jane's unused estate tax exemption of $4,430,000 to himself ($5,430,000 minus the $1,000,000 exemption used on the life insurance passing to Jane's children.) The assets that Jane left to John qualify for the unlimited marital deduction and do not use any of Jane's estate tax exemption. After filing the return, John will have his own exemption of $5,430,000 plus Jane's unused exemption of $4,430,000 for a total of $9,860,000. John can use the exemption to shelter lifetime gifts or transfers at death.

The portability provisions do not apply to the generation skipping transfer tax exemption, however. For individuals who intend to maximize the amount exempt from the generation skipping transfer tax, it would be advisable to maintain assets in each spouse's separate trust. The first spouse to die would keep assets in his or her trust for the benefit of his or her spouse, children and grandchildren, if generation skipping transfer tax planning is a priority.