Estate Planning and the Portability Provision
Stephen Foster
Estate Planning and the DSUE, or the Portability Allowance
Estate planning, done properly, is necessarily complex. And, the greater the wealth at play the greater the need for complexity. This is not an activity left to a novice. Genuine and thorough estate planning must be performed by trained and experienced professionals. A lifetime of wealth accumulation should not be treated lightly when it comes to its disposition—that is, taxation—at death. A well-executed and formal estate plan can save millions for an individual’s family and loved ones. “Well-executed” means details are not overlooked. “Well-executed” means that all financial eventualities be considered and accounted for. Finally, it means the planner is immersed in estate planning practices and knows important details that must be considered, whether employed in the final plan or not.
Estate Planning and DSUE
One important part of any estate planning work, when married individuals are reviewing their estate options, is something called the DSUE, or “deceased spouse’s unused exclusion.” DSUE is also referred to as the portability provision or allowance. Using one term or another does not change the meaning of the provision at all. In the broadest possible terms, when it comes to estate planning, portability simply means “porting over” from a deceased spouse to a surviving spouse any unused estate tax exemption. This provision was enacted nearly ten years ago in legislation known as The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. In 2013 legislation, portability was extended indefinitely.
Before Portability
Before portability became law, married couples needed to set up a by-pass or credit shelter trust. These would be a repository for the deceased’s unused estate tax exemption. This preserved the assets from taxes—thereby eliminating double taxation—on the subsequent death of the surviving spouse. If the deceased spouse had any available estate tax exclusion left, it was effectively lost. Portability addressed that problem.
The Estate Tax Exemption
Simply put, the estate tax exemption allows an individual to preserve certain assets from taxation at time of death. Over long periods of time, this exemption has changed significantly. For tax year 2019, the IRS announced the exemption will equal, per individual, $11.4 million. This amount, indexed annually to the inflation rate, is scheduled to be phased out of existence in 2025. What new dollar level will exist in 2025 would be anybody’s guess. Once an individual, not married, exhausts his or her exemption, the remainder is taxed at 40 percent.
Under these exemption rules, a married couple would collectively have an exemption of $22.8 million in 2019.
Here is a list of estate tax exemptions and the estate tax rate for the last eight years:
Year Over Year Estate Tax Exemption Estate Tax Rate
2012 $5,120,000 35.0%
2013 $5,250,000 40.0%
2014 $5,340,000 40.0%
2015 $5,430,000 40.0%
2016 $5,450,000 40.0%
2017 $5,490,000 40.0%
2018 $11,180,000 40.0%
2019 $11,400,000 40.0%
Here’s an example, without using DSUE. It’s the year 2018, and John, not married, passes away. John has an estate at death valued at $16.5 million. Earlier he set up an estate plan—and established a like provision in his will—within which he desired to have his assets at death be split evenly between his two brothers, Bill and Josh. Of the $16.5 million, $11,180,000 is excluded from taxes. John’s taxable estate is thus $5,320,000 ($16.5 million minus $11.18 million). What remains is taxed at 40 percent, meaning the two brothers share equally in the remaining 60 percent ($5,320,000 times .6 equals $3,192,000).
Here’s how the assets look after John’s death. Bill and Josh both will inherit $5,590,00 with no tax penalty ($11,180,000 times .5). Plus, each will receive 50 percent of what is left after the 40 percent estate tax rate on $5,320,000, or $1,596,000 each. The total to each brother equals $7,186,000 ($5,590,000 plus $1,596,000).
This hypothetical calculation does not bring the portability provision into play at all.
Here’s the significant point from the example above: taxes at death have a consequential impact on what your heirs get to keep at the point of inheritance. Also, note this: certain states, but only a few, have chosen not to follow federal statutes and may have rules far more restrictive. A well-done and comprehensive estate plan will look at all applicable rules, federal and state, and take these into account. Otherwise, the likelihood for unnecessary tax exposure increases while inheritance dollars may take a significant and unnecessary hit. A qualified and conscientious wealth management strategist will help you avoid any miscues.
So, how does DSUE truly work?
Estate Planning: Porting Over Excess Exemption Dollars
In brief, here’s what DSUE, or portability, means. It allows an executor, or a specifically designated individual, to elect to file a decedent’s estate tax return in such a way that it “ports” to the surviving spouse/family members any unused estate tax exemption. Rules exist for the filing of this estate tax return. A knowledgeable estate planning professional will make certain these filing requirements are met. Generally, the estate tax exemption DSUE form must be filed within nine months of the spouse’s death.
Let’s take John again, but under different circumstances. In this example, he’s married to Anne. This time, John has an estate valued at $15 million. Anne’s estate is valued at $13 million. John and Anne have two children, Mary and Adam. Several years earlier the couple put together an estate/financial plan that deliberately incorporated portability. John dies in 2018 and Anne, his executrix, files an estate tax return that formally establishes portability (a specific tax form issued by the Internal Revenue Service). Without being overly simplistic, this allows Anne to retain the amount of the estate tax exclusion that John did not use.
It works like this.
In 2018, John dies. His estate tax exclusion for that year would have been $11,180,000. He used none of it in the form of gifts; he died with his full exemption intact. Anne, by virtue of the planning the two had undertaken, becomes the recipient of all her deceased husband’s exemption. She now has her tax exemption, which in 2019 is $11,400,000, plus John’s exemption from 2018 ($11,180,000) when Anne filed the portability tax forms. Her total estate exemption is therefore $22,580,000 (which includes John’s exemption of $11,180,000 the year he died). Both John and Anne, in 2019, are now deceased. John’s estate is still valued at $15 million and Anne’s at $13 million. Total estate assets are $28 million.
Children Mary and Adam are designated as 50/50 recipients of their parent’s estates. Their total estate tax exemption will be John’s 2018 exempt amount of $11,180,000 plus Anne’s 2019 exemption amount of $11,400,000. The total is $22,580,000. This amount goes to the children free of estate tax. The difference between the full value of the estate, $28 million, and their collective exemption of $22,580,000 is $5,420,000. This is taxed at 40 percent, leaving the children with 60 percent.
Mary and Adam both will share equally in the following: $22,580,000 plus $3,252,000. Each, accordingly, receives $12,916,000, net. Wealth at this level, and certainly higher, cannot be preserved inter-generationally without the necessary and sophisticated estate planning that takes available rules and allowances into account.
Generally, in the case where there are multiple spouses, the individual filing for portability must use the estate valuation numbers of the most recent spouse to die.
Estate Planning: Summary
There are no margins when it comes to estate planning. The expert planner will be fully knowledgeable of, and conversant in, all relevant principals at play for individuals undergoing the process. Mistakes can cost millions. Planner ingenuity can save millions. Do not take this exercise lightly. Seek out expert planners. Ask for references. Proactively ask about the portability provision: it can save you millions.