Estate Tax Portability Lost Unless Form 706 is Filed

Estate Planning

By Melanie LaSota

One may be tempted to think that the $5 million estate tax exemption authorized by Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 is sufficiently generous to send many estate tax return preparers to the unemployment line. Ironically, due to a new concept known as “portability”, estate tax return filings for decedents dying in 2011 and 2012 are expected to reach historic highs.

Traditionally, the estate tax exemption belonged to each of us individually and could not be shared. If a husband and wife had “I love you” wills that left everything to the survivor, the unused estate tax exemption of the first spouse to die was lost forever. The right of portability granted by the Act provides relief by allowing surviving spouses to apply the unused portion of the deceased spouse’s unused exclusion amount to reduce their own estate tax liability.

By way of illustration, assume that Husband and Wife each own $5 million in assets and that Husband dies in 2011, leaving his entire estate to Wife. Further assume that Wife dies later in 2011 with a taxable estate of $10 million. Under the old regime, Wife could apply her $5 million exemption but would be subject to estate tax on the remaining $5 million. With portability, Wife can use Husband’s unused $5 million exemption, thus passing her entire estate free of taxes.

Portability is not a substitute for high-quality estate planning. Most importantly, unless the law is changed, portability is only available if both married individuals die prior to December 31, 2012. In addition, portability applies only to the last deceased spouse. Referring to the above example, if Wife remarries and outlives her second spouse, she will forfeit her first husband’s unused exemption. Finally, portability does not apply to the generation-skipping transfer tax exemption, so families that wish to include grandchildren or more remote descendants in their estate plans must continue to rely on traditional planning techniques.

An essential feature of portability is that the surviving spouse does not automatically inherit the deceased spouse’s unused exemption. Notice 2011-82, released on October 17, 2011, alerts executors that a federal estate tax return must be timely filed in order to elect portability, even if the value of the estate does not exceed the minimum filing threshold. A return is timely if it is filed within nine months from the date of decedent’s death. An extension request, filed no later than the nine-month deadline, automatically postpones the time to file the return, including the right to claim portability, for six additional months. It is not necessary to check a box on the return or otherwise make an affirmative statement to elect portability.

The Treasury and the IRS foresee that, as a general rule, most married couples will want to preserve the unused exclusion amount of the first spouse to die. Accordingly, a dramatic increase in estate tax return filings is anticipated. Many of these returns will be submitted by estates that would not otherwise be obligated to file. Commentators have expressed concern that requiring the filing of an otherwise unnecessary estate tax return imposes an expensive and time-consuming administrative burden on the executors of smaller estates. Furthermore, the nine-month filing deadline leaves little advance notice for uninformed taxpayers caught by surprise.

The clock is ticking for fiduciaries weighing the benefits of portability against the time and expense of filing an estate tax return. The due date for decedents who passed away in early 2011 has already passed. As of this writing, the IRS has no plans to provide relief to taxpayers who miss the filing deadline. Those still uncertain are advised to keep in mind the ability to request the six-month filing extension in order to keep the portability option open.

Michael W. Darpino, LL.M., JD, MBA also contributed to this Insight.

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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

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