Important Estate Tax Portability Update Announced

Aug 9, 2022Business, Estate & Retirement Planning

If the federal estate tax exemption is cut approximately in half in 2026, as is currently scheduled, it may create significant issues for Minnesota taxpayers. The matter becomes especially challenging when one considers what may happen if the portability election is not made. The portability election provides married couples a powerful planning tool, or if one spouse has already passed, a pathway to additional estate tax savings. In fact, recent changes have extended the deadline by which certain taxpayers can make the election. However, even as an extended late election, it is not automatic, and requires taxpayers to pay careful attention to filing details. To help clients, prospects, and others, Smith Schafer has provided a summary of the key information below.

PORTABILITY, EXPLAINED

Portability allows one spouse to transfer his or her unused exemption amount at death (also called the Deceased Spousal Unused Exclusion amount, DSUE) to the other. In so doing, both spouses can use up to their full federal exemption, currently $12.06 million per individual. This allows a married couple to exclude $24.12 million ($12.06 million each) from estate and gift tax in 2022. Individuals can give away during their lifetime and/or at death the federal exclusion amount and avoid federal estate tax on this same amount.

To elect portability, the estate of the first deceased spouse needs to file Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. The estate tax return is due within nine months of death and can be extended for another six months if the estate timely files an extension. Because the federal estate tax exemption is set to revert to pre-2018 levels in 2026, high net worth married couples will need to closely evaluate their estate planning strategy with the new late portability election in mind. Especially for Minnesota residents, whose estates will be under different rules at the state level, portability is a way to maximize tax planning.

LATE ELECTION FOR PORTABILITY

Effective as of July 8, 2022 the late portability election has been extended to on or before the fifth anniversary of the first spouse death. Previously, estates generally had two years to make the election on Form 706. The IRS has considered and granted later portability elections, but estates had to go through a lengthier, costly process of obtaining a private letter ruling. Because portability can only be elected on Form 706, estates that fall under the federal filing threshold and therefore aren’t required to file Form 706, may have missed the election simply by not knowing about it or perhaps thinking they did not qualify.

Eligibility for late portability hinges on these requirements:

  • The deceased spouse must have a surviving spouse, have been a U.S. resident or citizen, and died after December 31st, 2010.
  • Form 706 wasn’t required to be filed based on the value of the gross estate.
  • An estate return was not filed within the time required

Consistent with previous IRS guidance, estates that should have filed but didn’t – or missed the deadline– are ineligible.

Updated guidance from the IRS allows for a simplified method of electing late portability. Though the IRS won’t contact eligible estates, the surviving spouse, executor, or other appointed representative may simply make the needed filing. A private letter ruling, and the process that goes with it, is unnecessary.

PROPOSED MINNESOTA ESTATE TAX PORTABILITY

Like 11 other states and Washington, D.C., Minnesota applies an estate tax, which can be a gap in tax planning that Minnesota married couples may be unprepared for. Up to $3 million is exempt from the state’s estate tax. From there, state estate taxes range from 13 percent (for estates starting at $3 million) and go up to 16 percent (for estates valued above $10 million). 

With a much lower exemption, many married couples have an estate subject to Minnesota estate tax. And in Minnesota, portability between spouses has not been allowed.

THAT COULD CHANGE

New in 2022, there’s a proposal to modify tax law to allow some level of spousal unused exclusion amounts. It would be effective as of June 1, 2022. The new law would allow any unused exclusion amount less than $3 million to be transferred to the surviving spouse.

Like the federal portability election, the surviving spouse or appointed estate representative would need to file an estate tax return and make the needed election. Once made, it is irrevocable.

Portability is one piece of a larger estate planning strategy. Married couples shouldn’t rely on it as the primary means to minimize or escape federal estate tax. Lifetime gifts, certain types of trusts, and the generation skipping transfer tax are other potential factors to consider. Finally, portability at the federal level might not be worth it for estates that are under the federal exemption, but if Minnesota’s proposed law passes, it’s still a valuable tool at the state level.

CONTACT US

The recently announced changes to the federal late portability election is good news for high-net-worth and other taxpayers. The benefit doubles if state tax laws are changed to permit a higher exclusion. If you have questions about the information outlined above, or need assistance with an estate tax matter, Smith Schaefer can help. For additional information, click here to contact us. We look forward to speaking with you soon.

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