Portability – Another Reason for the Election

Take-Away: Lifetime gifts maximize the value of a portability election.

Background: Previously the benefits of a portability election have been covered. The challenge has been to encourage a surviving spouse to incur the expense of preparing and filing a fully complete, timely Form 706 on which a portability election is made. Surviving spouses are naturally anxious about incurring additional expenses having lost their spouse and fears of their financial security loom in their minds. In addition, it is much easier to say that they do not want to incur the expense of filing a federal estate tax return when an individual’s applicable exemption amount is over $12 million. Consequently, persuading a surviving spouse to incur the additional expense of filing a Form 706 when there is no need to file the estate tax return, just to make a timely portability election is often a non-starter for advisors. Even after the sunset of the gigantic applicable exclusion amount starting in 2026 is mentioned, that date often seems too far away to register with the surviving spouse That said, earlier this year, the IRS has provided yet another good reason for the surviving spouse to incur the expense of filing a Form 706 federal estate tax return and elect portability.

Portability: A surviving spouse who makes gifts, or the estate of the surviving spouse, is entitled to apply, in addition to the surviving spouse’s own applicable exemption amount, or basic exclusion amount, (BEA) the deceased spouse’s unused exclusion amount (DSUE)that is formally ported by election to the surviving spouse, so that the sum of both the spouses’ BEAs may be potentially used in their entirety to shelter taxable gifts of the survivor’s taxable estate from estate taxation. [Regulation 20.2010-2.]

Ordering Rule: Treasury Regulations then were updated to add to the benefits of a portability election. The DSUE will apply to a surviving spouse’s own gifts before his/her gifts can utilize the survivor’s own BEA. [Regulation 20.2010-1(c)(1)(ii)(A).] If the surviving spouse remarries and dies after 2026 but before the new spouse does, this ‘ordering’ rule will tend to preserve the surviving spouse’s own BEA. This is helpful because the DSUE remaining on the death of the surviving spouse cannot be ported to benefit the spouse in the subsequent marriage.

Use-It-Or-Lose-It: Initially it was thought that when the applicable exemption amount sunsets in 2026 that there will be an automatic reduction in the DSUE to the lower amount that will be available by the surviving spouse either to shelter either lifetime taxable gifts or the survivor’s estate federal estate tax liability.

Internal Revenue Bulletin 2022-20: Treasury updated its Proposed Regulations earlier this year and provided a new example that essentially provides that the DSUE is not reduced when the 2026 sunset occurs with regard to the applicable exemption amount. This Proposed Regulation takes into account the increased BEA and the 50% sunset reduction to the BEA that is scheduled to occur on January 1, 2026. The following Tony and Dawn example shows the impact of this change, found at Example 3 in the Proposed Regulations.

Example: Dawn’s husband Tony died when the applicable exemption amount was $11.4 million. Tony had made no taxable gifts and he had no taxable estate. The Personal Representative of Tony’s estate elected portability to allow Dawn to take into account Tony’s $11.4 million DSUE amount. Dawn made no gifts of her own, nor did she remarry. Dawn dies in 2026 after the sunset occurs, when the applicable exclusion amount has dropped to $6.8 million ($5 million inflation-adjusted over the past 9 years.) Because the total of the amounts allowable as a credit in computing the gift tax payable on Tony’s post-1976 gifts attributable to the basic exclusion amount is less than the credit based on the basic exclusion amount allowable on Tony’s date of death, the credit to be applied for purposes of computing Dawn’s estate tax liability is based on Dawn’s estate’s available $18.2 million applicable exclusion amount, which consists of Dawn’s estate’s $6.8 million BEA and on Tony’s date of death BEA of $11.4 million, for a total of $18.2 million.

In short, the scheduled sunset of the applicable exclusion amount does not apply to the larger, albeit still unused, DSUE.

Conclusion: When a spouse dies before 2026 and that deceased spouse’s unused DSUE is ported to the surviving spouse, any unused portion of the top half of SDUE will not expire after 2025. This may be reason enough to incur the expense of filing a Form 706 on which a timely portability election is made. Moreover, when it comes to using DSUE, lifetime gifts by the survivor are more tax efficient than transfers at death, since the value growth between the date of gift and the date of the survivor’s death cannot form any part of the surviving spouse’s eventual taxable estate. In short, lifetime gifts maximize the value of deploying a DSUE.