What Is Portability for Estate & Gift Tax?

On January 2, 2013, the American Taxpayer Relief Act of 2012 (ATRA) was signed into law by President Obama. This turned out to be a significant act because as a result, two significant tax laws dealing with estates and gifts became permanent. The act itself basically expanded the opportunities for taking advantage of the portability estate tax.

What Is Federal Estate Tax?

Estate tax is a tax imposed by the government on estates when someone passes away and passes their assets on to heirs or beneficiaries. These assets include such things as retirement accounts, real estate, and cash. The threshold in 2021 was $11,700,000 per person and twice that for married couples. This threshold increases pretty much on an annual basis and is based on inflation.

There is also a possibility that the estate could be subject to a state estate or inheritance tax. Be sure to check with your state to see if taxes on the estate apply on both the state and federal level.

Whether estates pay federal or state estate taxes is determined by the size of the estate upon death, the value of large gifts made while alive, and whether or not any of your property is exempt.

How Does Estate Tax Portability Work?

If a spouse dies and hasn’t used any of their gift tax or estate exemption, the deceased spouse would pass $11,700,000 on to the spouse that remains alive. As a result, the living spouse would shelter up to $23.4 million of their estate.

As a result, the surviving spouse not only has his or her own exemption but also the unused exemption of their deceased spouse. If a spouse dies and the estate value doesn’t use up all of the exemption, then the unused portion of the tax exemption of the deceased spouse’s estate can be transferred over to the spouse that is left behind.

Exemptions are deducted from the estate value which means that only the remainder is subject to the taxation of the estate.

How Do You Claim Portability?

The surviving spouse does not automatically the deceased spouse’s exemption. To claim portability, IRS Form 706 (Estate and Generation-Skipping Transfer tax return) must be filed. This must be filed at the time of the deceased spouse’s death so that you can elect to add the deceased spouse’s unused exemption to the surviving spouse’s exemption.

A spouse who has been widowed several times can only use the unused exemption of the most recent deceased spouse. Portability of the deceased spouse’s unused portion of the exemption only applies to the surviving spouse if the deceased spouse died after December 31, 2010.

Once you elect portability, there is no statute of limitations on the IRS auditing the estate tax return of the decedent spouse to determine the unused amount of the exemption available to the living spouse. Additionally, electing portability is irrevocable.

What is Generation Skipping Transfer Tax?

The Generation Skipping Transfer Tax (GST) is a federal tax levied on the transfer of assets an individual makes either while alive or at the time of death. This transfer is made to one generation removed. A transfer from a grandparent to a grandchild is an example of a generation skipping transfer. 

If the surviving spouse elects to transfer the deceased spouse’s unused exemption through portability, the GST exemption cannot be applied along with the federal estate exemption. The deceased spouse’s GST exemption would then be lost.

What is the Federal Gift Tax?

If you want to leave a significant amount to heirs and your estate falls within the limits of the taxed estate, then you should do some estate planning.

If you want to minimize your estate tax, you can make a donation to charity which can be deducted at tax time or given to heirs who will be affected by the taxes on the estate. You could have given up to $15,000 away in 2021 and applied that to as many individuals as desired. This is also known as the gift tax exclusion. If you give any more than $15,000 to any one heir, you will be subject to the gift tax rate of 40%.

Therefore, the estate tax is the tax levied on the net worth of assets you leave upon death and the gift tax is the net worth of assets you give away while alive.

Gift and estate tax laws are complex even if you are an accounting professional. The laws on these two taxes have changed drastically over the last decade, especially when it comes to portability. If you have any questions regarding your client’s estate planning, be sure to check out Corvee software for accounting firms. The software makes tax planning recommendations for your clients and will help run your firm efficiently which are two stepping stones to growing your tax practice. It’s a win-win situation for both accounting professionals and their clients.