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Exemption Portability - What is it, and how does it work?

The term "portability" is used in many contexts, but in the estate planning context portability describes the way a surviving spouse can use the remainder of a deceased spouse's unused exclusion amount to further shield her or his estate from tax liability. Portability first came about in 2010 as a temporary concept in the Tax Relief, Unemployment Reauthorization and Job Creation Act of 2010. It was set to expire on December 31, 2012, but Congress, in the American Taxpayer Relief Act of 2012, made portability a permanent part of the estate and gift tax exclusion. The current unified exemption for estate and gift taxes is $5.43 million (for the year 2015), so portability allows for a potentially very large tax break for a surviving spouse's estate.

To understand how portability works in its most basic form, assume that H and W, a married couple, have $4 million and $6 million, respectively. H dies, leaving $2 million to his children and $2 million to W. The $2 million passing to H's children falls under the $5.43 million exemption, while the $2 million left to W is excluded as a marital deduction. W now owns $8 million, and she thereafter dies. Even though she owns $8 million, her estate has an exemption of $5.43 million, as well as the $3.43 million remaining from H's exemption, so no estate tax will be due upon W's death.

Portability does not automatically transfer the remainder of the decedent spouse's unused exclusion amount to the surviving spouse, however. The executor of the estate of the first spouse to die must make an affirmative election on a timely-filed estate tax return, which necessitates filing a return even if one is otherwise unnecessary (i.e. when no tax is due).

Finally, in a situation involving multiple marriages, portability only applies to the last deceased spouse. So, if, in the example above, W marries H2 after the death of H, if H2 dies with an estate of $4 million that he leaves to his children, W's estate will only receive the remaining $1.43 million exemption of H2's estate, not the $3.43 million exemption remaining from H. If she dies with $8 million, her exemption will be $6.86 million, but $1.14 million will be taxed. There is a bit of play to this, however - if W marries H2 and makes a gift of $3.43 million to her children while H2 is alive, she uses up the unused exclusion amount remaining from H's estate, as H is her last deceased spouse at the time of the gift. Her exemption remains intact, and she receives H2's unused exclusion amount as well when H2 dies. Thus her estate is ultimately free from estate tax.

Portability can be confusing, but it's a powerful tool for large estates. For information on how portability works with estate planning, contact the attorneys of McBrayer today.

This article is intended as a summary of federal and state law and does not constitute legal advice.

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