Take-Away: If a spouse dies without using his/her unified transfer tax exemption, that exemption can be ported and used by the surviving spouse to shelter either lifetime gifts by the survivor, or applied to shelter federal estate taxes on the surviving spouse’s death. But if the deceased spouse’s ported  transfer tax exemption is not used to shelter lifetime gifts by the surviving spouse, that ported exclusion amount could automatically be cut in half if the surviving spouse dies after December 31, 2025. Knowing that risk, it would be wise for the surviving spouse to make, and thus use, the deceased spouse’s ported applicable exemption amount with lifetime taxable gifts.

Example: [for ease of explanation, the transfer tax exemption is rounded down to $11 million currently, and $5 million after the temporary increase in the exemption amount sunsets] Husband dies in 2019. He never made any taxable gifts. Therefore, due to the 2017 Tax Act temporary increase, Husband’s estate has available $11 million in transfer tax exemption. Husband leaves his entire estate to Wife, so the full marital deduction is claimed, no federal estate taxes are paid, and because the executor of Husband’s estate makes a portability election on Husband’s 706 federal estate tax return, his full $11 million of transfer tax exemption is now available, or ported,  to Wife. Wife makes no taxable gifts. Wife dies in 2026.

Question: What is the applicable federal transfer tax exemption available to Wife’s estate in 2026? $16 million [the ported $11 million that she received on Husband’s death in 2019 plus Wife’s own $5 million, after the temporary increased cause by the 2017 Tax Act lapses? Or, will Wife’s transfer tax exemption available to her estate in 2026 be $10 million, her own $5 million plus what Husband’s transfer tax exemption would have been in 2026, another $5 million?

Background: We are all familiar with the temporary increase in each individual’s applicable exclusion amount that came with the 2017 Tax Act. We also know that the doubling of that applicable exclusion amount is only temporary, with the exclusion amount set to return to its 2017 $5 million level beginning in 2026.

Ambiguity: What is unclear from the 2017 Tax Act, and its ‘doubling’ of the transfer tax exemption, is its impact with regard to the Tax Code’s existing portability rules.  The existing portability rules do not address the implications of the ‘up and down’ exclusion amount on a deceased spouse’s applicable exemption amount that is ported to a surviving spouse or available to the surviving spouse’s estate.

Existing Tax Code Provisions: The unified federal transfer tax rules are located at IRC 2010, aka the unified tax credit.

  • The federal estate tax unified credit that is available to offset a decedent’s federal estate tax liability is the amount of estate tax computed as if the amount of the taxable estate were equal to the applicable exclusion amount. [IRC 2010(c)(1).]
  • The applicable exclusion amount is defined as the decedent’s basic exclusion amount plus the applicable exclusion amount of the last predeceased spouse. [IRC 2010(c)(2).]
  • The deceased spouse’s unused exemption amount [DSUEA]  is restricted to the $5 million basic exclusion amount in effect when the surviving spouse dies. [IRC 2010(c)(4).]

These provisions could suggest that the larger DSUEA would be available to shelter the deceased surviving spouse’s federal estate tax liability. But the way the as if wording is used in the Tax Code it is also possible that the DSUEA amount could be interpreted to mean what would have been available to be ported if the first spouse to die had died in 2026, meaning only $5 million would be ported to and available for use by the survivor’s estate. The hope had been that the new Regulations that implement the 2017 Tax Act would address the impact of the automatic sunset of the exemption amount on the DSUEA amount. But no further guidance was provided.

Lifetime Gifts: As has been previously reported, there is some guidance on the use of the DSUEA found in the Treasury Regulations. Those Regulations direct that the deceased spouse’s unused exemption amount (DSUEA) will be applied to lifetime gifts made by the surviving spouse, before the surviving spouse-donor’s own basic exclusion amount is applied to the donor’s taxable gift. [Treas. Regulation 25.2505-2(b).]

Conclusion: Due to the ambiguity of how the doubled applicable exemption amount is to be handled when a portability election is after 2017, and the failure of the recently adopted Regulations that implement the 2017 Tax Act to address the ‘up and down’ applicable exemption amount when a portability election is made, it is a risk to assume that the enlarged applicable exemption amount will always be available to the surviving spouse’s estate to shelter federal estate taxes. If a spouse dies after 2017 with the larger DSUEA, the surviving spouse should consider lifetime gifts using that DSUEA to shelter the gift tax, ‘using it’ as opposed to possibly ‘losing it’ sometime after 2025. In addition, it is alway important to remember that it is the last predeceased spouse’s DSUEA that can be used, so a remarriage by the surviving spouse could also cause the DSUEA to either be diminished or completely lost.