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Portability - How to Eliminate Estate Tax

Filing estate tax return and electing portability when first spouse dies could eliminate future estate tax if the gift and estate tax exemption drops.

In 2022, the gift and estate tax exemption is $12,060,000. Lifetime gifts plus estate value above that amount will be taxed at 40% when you pass away.

If the amount of gifts made during your lifetime plus the value of your estate when you die is greater than the exemption, your children will have to pay an estate tax.

Because the gift and estate tax exemption is so big, most people don't have to worry about it. And for most married couples, it is even less of an issue, because both spouses get the exemption, which results in a total exemption of $24,120,000.

But the gift and estate tax exemption is not static. It changes.

In 1997, it was $600,000. In 2002, it was $1,000,000. In 2008, it was $2,000,000. In 2010,  there was no estate tax. In 2011, it was $5,000,000. This looks like it only goes up. But remember, last year Biden said he wanted to lower it to $3,500,000. And the exemption is already scheduled to drop to approximately $7,000,000 at the end of 2025.

When the first spouse dies, the surviving spouse can hedge against future changes by using a strategy called portability. Here's how portability works.

If the couple are California residents and the assets are community property, then the deceased spouse's estate is half the value of the total estate. If the total estate is $4,000,000, the deceased spouse's estate is $2,000,000. This is way below the estate tax exemption (currently over $12m), so there won't be an estate tax.

If the surviving spouse has her accountant file an estate tax return for her deceased husband, she can elect portability and bank her deceased husband's unused exemption. The unused exemption is the exemption at year of death minus the deceased husband's estate value. In our example, it would be $12,060,000 minus $2,000,000 equals $10,060,000. 

By filing the estate tax return, the surviving spouse can "port-over" or bank her deceased husband's unused exemption and it can be applied to her estate when she dies.

Why is this important? What if a future Congress and President lower the exemption amount to say, $2,000,000, and by then the surviving spouse's half of the estate is worth $3,000,000? Her estate would be subject to estate tax ($3M estate minus $2M estate tax exemption equals $1M. If the estate tax rate is 40%, then her children would have to come up with $400,000 to pay the estate tax.

But in our example, her family can apply her husband's unused exemption ($10,060,000) and wipe out the estate tax.

The big gift and estate tax exemption amount we have now may not last forever. If a spouse dies in a year with a big exemption amount, it would be worth it to file an estate tax return to port over the unused exemption amount. No matter what the exemption is when the survivor dies, the unused exemption can be used if the estate tax return was filed after the first death.

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