Portability of the estate tax exclusion amount

Due to the passage of the American Taxpayer Relief Act of 2012 (ATRA), taxpayers saw the portability election made permanent.  What exactly does this mean for the average Nebraska and South Dakota farmer or rancher?

First, we have to discuss what portability election is.  As you likely know, in 2013, every taxpayer has a unified credit of $5.25 million.  This means a taxpayer can pass at death or gift throughout his or her lifetime $5.25 million prior to the imposition of the estate and gift tax.  But what if a person does not use the entire $5.25 million?  In other words, what if the total assets of a person total $3.25 million?

Assuming you are married (sorry … this won’t work if you are unmarried), you have the option of making a portability election.  A portability election is a mechanism for spouses to ensure full use of each of their exemptions, totaling $10.5 million in 2013.  Portability allows a surviving spouse to use the deceased spouse’s unused exclusion amount for estate and gift taxes.

An example is the best way to understand the math of the portability election.  Assuming no other estate planning, the taxable estate of the deceased spouse is $3.25 million.  Most of that amount is due to the value of farmland.  The deceased spouse’s unused exclusion amount is $2 million.  The surviving spouse can then elect to “port” the $2 million unused exclusion amount, thus raising the surviving spouse’s exclusion amount to $7.25 million.

The election to port, however, must be done on an estate tax return for the deceased spouse.  This means an estate tax return must be filed even when no estate tax is due.  If you are filing an estate tax return solely for the purposes of a portability election, a good faith estimate of asset value is required.  The estate tax return is due nine months after the deceased spouse’s death, before any extensions for filing are requested (an extension is typically six months).

Why is knowledge of the portability election important?  Portability can function as a default estate planning tool to ensure the maximum exclusion amount between spouses is used.  No prior planning is required, unlike with a trust, will, or business entity.  It does require, however, the timely filing of an estate tax return after the deceased spouse’s death.

The portability election can be especially important as land values continue to rise.  The ability to transfer the deceased spouse’s unused exclusion amount to the surviving spouse may allow farm and ranch land to be transferred without imposition of the estate and gift tax.  As many farmers and ranchers know, land values are rising faster than the rate of inflation.  There may be a legitimate concern that the estate tax exemption, which is indexed to the rate of inflation, may not be able to keep up with land valuations.  Thus, while the taxable estate of the deceased spouse may not reach the estate tax exemption (in 2013, $5.25 million), the taxable estate of the surviving spouse may exceed the estate tax exemption because the rate of inflation is lower than rising land values.  Portability is a means to capture the deceased spouse’s unused exclusion amount, which may provide enough of a cushion to ensure the estate tax is not paid due to the combining of the surviving spouse’s exclusion amount and deceased spouse’s unused exclusion amount.

Other things to keep in mind: the portability election is for the deceased spouse’s unused exclusion amount.  If the surviving spouse remarries and does not use the deceased spouse’s unused exclusion amount and the second spouse passes, the surviving spouse no longer can use the unused exclusion from his or her first spouse.  Additionally, while it is likely that the portability election will remain in the tax code permanently, that can all change in an instant with new legislation.  Finally, there is no method to retroactively elect to port the unused exclusion amount — the election must be done in the nine months (or after any extensions have been been granted) after the deceased spouse’s death.

Portability may be an option or other “traditional” estate planning techniques such as trusts may be required.  Do you want to discuss the possibilities?  You are welcome to contact us for a one-on-one mentoring session, attend a workshop or attend a clinic.