Thanks to the Internal Revenue Service’s release of Rev. Proc. 2022-32 over the summer, married couples who are not otherwise required to file an estate tax return at the death of the first spouse now have substantially more time to make a portability election, permitting the transfer of the deceased spouse’s unused federal estate tax exemption to the surviving spouse.
The Importance of Portability
Currently, each individual has a federal gift tax and estate tax exemption amount of $12,060,000 (in 2022). Any exemption amount not used for lifetime gifts remains available at death to offset federal estate taxes on the individual’s taxable estate. Amounts left to a surviving spouse or to charity at one’s death typically do not require the use of a decedent’s remaining exemption amount because they qualify for the estate tax marital and charitable deductions. Before 2011, if a decedent left his or her entire estate to a surviving spouse, or if the value of the decedent’s estate was lower than his or her remaining exemption amount, the tax benefit of any unused exemption was lost. To avoid this waste, typical estate planning for married couples involved creating a “bypass” or “credit shelter” trust to receive the deceased spouse’s remaining exemption amount, which prevented those assets from being taxed again in the surviving spouse’s estate.
In 2011, federal law changed to allow the transfer of a deceased spouse’s unused exemption amount to the surviving spouse, enabling the survivor to apply the exemption amount “inherited” from the first spouse against lifetime gifts or to his or her estate at death. The intention was to protect married couples from the inadvertent waste of their exemption amounts by simplifying the planning needed to fully use both exemptions. If the exemption amount drops to $5 million per person (inflation adjusted), as it is scheduled to do in 2026, the importance of this portability election will increase as more families become exposed to potential federal estate tax.
How and When to Elect Portability
Any estate representative wanting to make a portability election for a deceased spouse’s estate must file a federal estate tax return, regardless of whether a return would otherwise be due.
Estates over Filing Threshold. If the deceased spouse’s estate is filing an estate tax return because the gross estate exceeds the filing requirement threshold (i.e., the gross estate, plus adjusted taxable gifts and specific exemptions, exceeds the decedent’s exemption amount), the estate representative must make the portability election on the return, which is due nine months (or 15 months if an extension is obtained) after the date of the decedent’s death.
Estates Filing for Portability Only. Unlike estates over the estate tax filing threshold, estates filing estate tax returns solely to make the portability election (a portability-only return) have far more time to file their returns after Rev. Proc. 2022-32. A portability-only return may now be filed anytime on or before the fifth anniversary of the decedent’s death. The return must follow the simplified method for obtaining the extension as detailed in Rev. Proc. 2022-32, including a statement that the return is being “Filed Pursuant to Rev. Proc. 2022-32 to Elect Portability under Section 2010(c)(5)(A).”
This extended filing deadline is helpful for estates below the filing threshold, as those estate representatives may not understand the need to file a portability-only return or may not discover the need to elect portability for a surviving spouse until after the federal estate tax return due date. If, despite the extended time frame provided under Rev. Proc. 2022-32, an estate filing a portability-only return fails to file within the extension window, it is still possible for the estate representative to seek relief under Treasury Regulations Section 301.9100-3 to make the portability election. That process is much more complicated, however, as the taxpayer must pay a user fee and submit a private letter ruling request for relief to the IRS showing that the taxpayer acted reasonably and in good faith and that the granting of relief will not prejudice the government’s interest.
Does Portability Eliminate the Need for Credit Shelter Planning?
While portability can prevent the loss of the first spouse’s unused exemption, for many families, the benefits offered by credit shelter trust planning may outweigh the simplicity of relying on portability. When considering how to proceed, both tax and non-tax factors should be reviewed, including:
- A credit shelter trust will protect the appreciation on assets held in the trust from subsequent taxation in the surviving spouse’s estate, while a portability election will not.
- Portability applies only to the federal exemption amount; most states with estate taxes, like New York, do not recognize portability. Married couples in those states who wish to make use of their state estate tax exemptions will still benefit from the use of credit shelter trusts.
- Portability also does not apply to the generation-skipping transfer (GST) tax exemption, which shields assets passing to grandchildren and later generations from GST tax. If there is a desire to create a long-term, multigenerational trust (a so-called dynasty trust), credit shelter planning can help preserve the deceased spouse’s unused GST tax exemption.
- There is no post-death inflation adjustment of the exemption amount transferred to a surviving spouse via a portability election. Moreover, if the surviving spouse remarries and also survives his or her new spouse, any unused exemption received from the first predeceased spouse is lost.
- If the surviving spouse is ill or incapacitated, a credit shelter trust can provide ongoing asset management, although there also will be ongoing trust administration requirements and costs. In addition, to effectively use a credit shelter trust, a married couple may need to shift and retitle assets between them to ensure that each spouse individually owns assets equal to the exemption amount and that those assets do not automatically pass to the surviving spouse (as jointly held property with rights of survivorship or assets paid by beneficiary designation).
- Assets held in a credit shelter trust will not receive a step-up in income tax basis at the surviving spouse’s death. Assets provided outright to, or in a marital deduction trust for, the surviving spouse, combined with a portability election, will permit a second step-up in basis for those assets at the surviving spouse’s death and prevent the loss of any exemption.
Although portability provides some simplicity in planning and administration, it will often work better as a post-mortem “cleanup tool” for nonexistent or improperly implemented estate plans. The new extended deadline for filing a portability-only return also should provide welcome relief to advisors and executors of eligible estates, who now have a greater opportunity to make the election, if advantageous, without the cost and burdens of seeking a private letter ruling. As always, however, it is important for married couples to seek guidance from their estate planning attorney to determine whether credit shelter or other tax planning techniques might be better suited to their particular needs.