The changing estate tax landscape makes it more important than ever for accountants and executors to file a federal estate tax return for portability when one spouse passes away. The 2017 Tax Cuts and Jobs Act doubled the lifetime estate and gift tax exclusion for decedents dying between 2018 and 2025. The estate tax exemption for 2021 is $11.7 million. But when the act sunsets on December 31, 2025, the exemption amount will revert back to $5,000,000, as adjusted for inflation. Increased spending due to the COVID-19 pandemic and the election of President Biden may bring a reduction even sooner.
Spouses can leave each other an unlimited amount of assets without generating any estate tax. The idea is that estate tax is owed on the surviving spouse’s death. However, by leaving all assets to the spouse, you are not using the deceased spouse’s exemption. Portability allows a surviving spouse to use the deceased spouse’s unused lifetime exclusion (DSUE) by simply electing to do so on IRS form 706. Therefore, if the first spouse to die has not fully utilized their federal estate tax exclusion, the unused portion can be transferred and used by the surviving spouse. The surviving spouse’s exclusion then becomes the sum of his or her own exclusion plus the DSUE amount.
In order for the surviving spouse to take advantage of the DSUE, an estate tax return must be filed within 9 months from the deceased spouse’s date of death. An extension request can extend the filing date for 15 months. The estate tax return must be filed even if no taxes are due. Many surviving spouses are not be aware of this requirement or assume they do not need the DSUE because the current exclusion amount is so high.
If an estate tax return is not timely filed, the surviving spouse loses the DSUE. Under the simplified method of Revenue Procedure 2017-34, the return can be filed within two years from date of death if no estate estate was due. However, if more than two years have passed, the only recourse is to request a private letter ruling from the IRS, which costs $10,000 just for the request.
This reduction of the federal estate tax will likely affect New York’s estate tax exemption. In New York, the current estate tax exclusion is $5,930,000. New York does not currently have the option for portability. Any exclusion amount unused by the first spouse to die is lost for New York estate tax purposes. New Yorker’s with sizable estates need to set up trusts to capture the spouse’s exclusion amount.
There is no downside to electing portability and using a spouse’s unused New York State estate tax exemption. There was concern that the IRS would deny the full benefit of DSUE (and gifts) made between 2018 and 2025 for those who die after December 31, 2025. Luckily, on November 26, 2019, the Treasury Department and IRS issued final regulations confirming that there will be no “claw back”. A decedent’s estate will not be taxed on gifts made when the higher exclusion amount was in place. On the surviving spouse’s death, the estate tax and DSUE amount will be calculated using the increased exclusion amount in place between December 31, 2017 and January 1, 2026.
A significant number of individuals will be subject to estate taxes when the federal exemption is reduced. Simple estate tax provisions allow couples to take advantage of a deceased spouse’s exclusion amount. One of the simplest fixes is to make sure to file for portability on time. An experienced estate planning attorney can advise you on estate tax issues and revisions you may need in anticipation of the coming changes.