I know what you’re thinking. Any article that promises to save you millions of dollars is likely bogus. I get that, because—well, let’s be honest, there are plenty of “get-rich-quick” scams out there. But in all seriousness, this isn’t one of those scams. There’s an often-overlooked estate tax tip that can allow certain individuals to shield millions—up to $12.06 million, to be precise—from federal gift and estate taxes. Seems too good to be true? It’s not.
These potential estate tax savings involve the concept of portability, also known as the deceased spouse unused exclusion (DSUE) rule. If those terms are foreign to you, don’t worry—they’re foreign to most people.
In this article, we’ll break down portability and DSUE to show how an individual could save $12.06 million.
To first understand these terms, we need to take a look at the federal estate tax exemption.
*Note — This advice is generalized and should not be considered specific financial or tax advice. If you have specific questions, it’s probably best to hire an attorney or tax specialist.
What is the Federal Estate Tax Exemption?
In the United States, each individual gets a certain exemption from federal gift and estate taxes. This exemption is known as the federal estate tax exemption. Unless your estate assets are greater than the exemption amount, your estate will not need to pay federal estate taxes.
The exemption amount varies from year to year with inflation. In 2021, the exemption amount was $11.7 million. With high inflation in 2021, the exemption amount was raised to $12.06 million in 2022.
Keep in mind that these numbers are technically per person. For a married couple, the exemption amount is $24.12 million in 2022. Understanding that point is critical in understanding portability and DSUE.
Let’s look at a brief example.
John Smith, an unmarried individual, passed away in 2021 with a total estate value of $15.7 million. Out of the total estate assets, $11.7 million fell within that year’s federal exemption amount—meaning that John did not have to pay federal estate taxes on those assets. The remaining four million exceeded the exemption threshold, so John’s estate did have to pay federal estate taxes on the four million.
Now, what if John had been married? That’s where portability comes into play.
What is Portability?
If you’re even remotely familiar with estate planning, you’ve likely heard the word “portability” used before. Portability is a fancy term that is often thrown around in estate planning jargon, but the concept is simple in itself.
Let’s go back to the example of John. If John had been married at the time of his death, his unused exemption amount would have transferred to his spouse—let’s call her Mary. So, in 2021, the $11.7 million unused exemption from John’s portion of the estate would have transferred to Mary Smith, which, counting her own estate exemption amount, gives her a federal estate tax exemption of $23.4 million.
This concept of portability is also called DSUE. Although the details behind DSUE are complex, it’s important to note that Mary Smith retains the DSUE amount even if she marries a new spouse. Let’s go back to our example:
We know that John Smith passed away in 2021, but let’s suppose that Mary Smith remarries in 2022 to Roger Brown. If Mary were to pass away in 2022, her estate tax exemption amount would then be the $11.7 million unused exemption amount that was transferred from John in addition to the $12.06 million that was her own estate exemption amount. So, in total, her federal estate exemption amount would be $23.76 million.
Now, Mary Smith does not retain the late John Smith’s unused exemption amount in all circumstances. If Roger Brown, Mary’s new husband, passed away in 2022, then Roger’s unused exemption amount would transfer to her. Mary would lose the unused exemption from John and gain the unused exemption from Roger. That would actually benefit Mary, since now her federal estate exemption amount would total $24.12 million (her $12.06 million exemption and Roger’s unused $12.06 million exemption).
Is your head spinning yet? If it is, don’t worry. If all the other information in this article doesn’t make sense, then there’s really only two critical lessons to take away:
Lesson #1: Portability is not Automatic
Portability is not guaranteed. Just because an individual passes away does not mean that their spouse automatically receives the DSUE amount.
Portability only occurs if Form 706—a United States Estate Tax Return—is filed on behalf of the decedent. In Part 6 of Form 706, found on page 4 of the document, the executor or individual completing the form must calculate the DSUE amount that is portable to the surviving spouse.
This is a critical step. The good news for any executor is that estates filing Form 706 automatically opt in to the portability election. Although the calculations must still be completed by the executor, portability will occur unless the executor chooses to opt out.
This brings us to the second lesson:
Lesson #2: File an Estate Tax Return for the Deceased Individual
Portability might not make sense for every estate. If an estate is far below the exemption threshold, then claiming portability just might not seem worthwhile.
But here’s the deal: unless an estate tax return is filed for the deceased individual, claiming portability is not an option. There are two ways to opt out of portability. The first way, as mentioned above, is to manually check the “opt out” box on page 4 of Form 706. The second way to opt out of portability is to never file an estate tax return for the deceased individual.
Why does that matter? Let’s go back to the example of our two beloved acquaintances, John and Mary Smith. This time, we’ll change the numbers a little bit.
John and Mary Smith were married for forty years and had an estate worth $6.5 million. In 2021, John passed away. All the assets were held jointly with right of survivorship, so the assets transferred to Mary upon John’s death. Because the total estate value was well below the threshold of $11.7 million in 2021, Mary Smith decided not to file an estate tax return for her deceased husband. Why bother with a difficult process when all the assets were now in her name?
Let’s suppose that Mary lives for another 20 years. Let’s also suppose that the exemption amount is $15 million in 2042. Over those two decades, the estate’s assets grow to a total of approximately $20 million.
Mary, who never remarried, now wishes she had elected for portability upon John’s death. Her exemption amount is only $15 million, meaning that she will have to pay federal estate taxes on the $5 million that exceed the current threshold. If Mary had filed an estate tax return upon John’s death, electing for portability, she would have both his unused exemption amount and her current exemption amount. She would not have to pay estate taxes upon her death.
Even though it can be a difficult process, filing Form 706 (the estate tax return) can be beneficial in the long run. Filing this form upon the death of a spouse can save millions of dollars, avoiding high taxes and future headaches.
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