Since the TCJA – Tax Cut Job Act was passed in 2017, things have changed with respect to estate tax planning and gifts. The one thing that remained unchanged was portability estate tax – a beneficial means of tax benefit that you should consider while creating your estate plan.
Typically, portability estate tax allows an executor to act on behalf of the deceased spouse to exercise the options available for estate tax exemption amount that remained unused at the time of death of a taxpayer.
The tax exemption change works with the federal gift and estate tax where the TCJA act doubles the existing exemption from $5 million to $10 million. Foreseeing the inflation, the TCJA has set to increase the exemption over time with the shift first made in 2018 with $11.8 million and $11.4 million in 2019.
According to the Taxpayer relief act 2012, which came into law in 2013 when President Obama signed the legislation, the two laws of gift and the estate tax were made permanent.
First, the legislation set the exemption amount for citizen and non-citizen residents of the United States from the gift and federal estate taxes at $5 million. The exemption amount for both citizen and noncitizen residents of the US is $5,490,000. However, the legislation did not make any change to the exemption of estate and gift taxes for noncitizen nonresidents from $60,000. Any amount increasing from the threshold will be taxed by 40%.
In addition, with the increased tax exemption, made permanent by law in 2017, a married couple will have a limitless marital deduction that allows them to pass the assets from one spouse to another. Plus, when the taxpayer passes, the inherited assets of the surviving spouse will be subjected to gift and estate taxes.
How does the Portability estate tax work?
Generally, the unlimited deduction for married couples allows them to delay paying the estate and gift taxes until one of them passes. However, in a condition where the surviving spouse is not a US citizen, then to bring the assets of the deceased spouse in use, a portion of the asset must be put in the Qualified Domestic Trust (QDOT).
The second thing that the legislation made permanent was the portability of estate tax. Portability enables the surviving partner to transfer the Deceased Spouse Unused Exempt Amount (DSUEA) to the surviving partner. This is done so the portability election can be made on time via a federal estate tax return.
Real-life Examples Against Portability estate tax
Keep in mind that the word ‘permanent’ entails a meaning that has been set for the time until Congress takes steps to modify or edit it. To understand it more clearly, let’s take an example of a couple who are US citizens.
A couple lived with a total estate of $6.0 million of all community estate property. The husband died in 2106, and his portion of the estate (half of the total community property) of $3.0 million was completely transferred to his wife. The limitless marital deduction will enable the whole $3.0 million to be transferred to his wife without using his husband’s $5.45 million exemption and paying federal taxes.
The non-exempted amount of $5.45 million would be portable and would be passed to his wife. The wife has to file the IRS Form 706 – federal estate tax returns to get the portability within 270 days after her husband’s death.
If the portability election is filed in time, the entire estate of $6.0 million will be named under the wife. Plus, she would have a $5.45 husband’s DSUEA along with her exemption amount of $5.45 million with respect to indexed inflation. This means a total of $10.9 million will be subjected to the exemption from gift and federal estate taxes. This appreciates her total estate and/or will enable a significant exempt amount reduction.
Now, what happens if a wife does not file the tax returns on her Husband’s federal estate to elect portability? The total estate would be $6.0 million as she will only receive her estate-exempted amount of $5.45 million in the event of her death.
In this case, the estate would pay 40% taxes on the amount that is exceeding the estate exemption amount. This 40% tax could be saved if she had been filing her husband’s federal tax returns in case of electing portability.
The above example shows the elect portability and exemptions for the individuals who are citizens or the surviving spouse is a citizen. The case can be different if the surviving spouse is not a citizen.
If a husband died in 2016 leaving a surviving spouse who is not a US citizen. The couple has a total of $6.0 million in the estate including all community property. At the time of the death of her husband, the total amount of his estate was $3.0 million. If the husband transferred half of the estate to his wife, he will use the 43.0 million from his $5.45 million exemption. This is because there would be no unlimited marital deduction when the property or estate is passed to a noncitizen until the estate passes through a Qualified Domestic Trust (QDT Trust).
The remaining $2.45 million from the exemption amount would be said to be portable to the wife. And then again this can only happen as long as the wife files IRS form 706 in order to elect portability.
If the portability election is filed in time, the estate of $6.0 million will be named under the wife. Plus, she would have a $2.45 husband’s DSUEA along with her exemption amount of $5.45 million with respect to indexed inflation. This means a total of $7.9 million will be subjected to an exemption from gift and federal estate taxes.
On the flip side, before passing, a husband leaves his portion of the estate ($3.0 million) in a QDT Trust under his wife’s name; the $5.45 million exemption amount would not be used as it goes through unlimited marital exemption. Further, the entire exemption amount will be portable to a wife as long as she will be filing Form 706 to elect portability.
The legislation regarding gifts and federal estate taxes has dramatically changed in the past few years. Precisely, the laws have cleared thoughts about portability. Once you decide to make an estate plan for your heirs, make sure to speak to an attorney. This is because in the past five years the legislations concerning estate for citizens and noncitizens and spouses have become a bit complex for a layman to understand. This is why it is always recommended to contact an estate attorney while preparing your estate plans.
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