What is an estate and gift tax exemption and why does this matter?
When a US taxpayer passes away, everything they owed and owed at the time of their death becomes their “estate” for tax purposes. Pursuant to federal law, they are allowed to transfer a certain dollar amount from their estate to other people or entities free of estate tax.1 This dollar amount that can pass estate tax-free is known as the “federal estate tax exemption” and is currently set at $12.06mm for 2022. This amount changes nearly every year, and is intertwined with the federal gift tax exemption. A deceased person’s federal estate tax exemption amount is the amount set for the year they died, reduced by any taxable gifts made by that deceased US taxpayer during their lifetime (their “exemption amount”).2
If an estate is over the threshold and federal estate tax is due, it is assessed on the value of the estate over the exemption. (For instance, if the estate is valued at $14.06mm, then the federal estate tax would be assessed on the $2mm difference at a rate of 40%, which is a whopping $800K in taxes!) Interestingly, some states also assess their own state estate tax, set their own exemption amounts (often a much lower bar than the federal exemption amount), and have their own methods of applying the tax.
Let’s use an example:
Take Mary and Tom, a married couple. Together, they own about $15mm in net assets. Mary was the breadwinner so some assets are in Mary’s name only (approx. $11.5mm), and some assets are in joint names (approx. $3.5mm). Neither Tom nor Mary have ever made any taxable gifts. Tom dies first, using $3.5mm of his $12.06mm estate tax exemption. This means that $8.56mm of Tom’s available estate tax exemption went unused at his death. Portability gives Mary, the surviving spouse, the ability to take the leftover portion of Tom’s available estate tax exemption (i.e., his “DSUE” which in this case is $8.56mm), and add it to her available estate tax exemption. This gives her an increased exemption amount of $20.62mm if she were to die in 2022.
Is DSUE the same thing?
DSUE or DSUEA is the acronym for “deceased spousal unused exemption amount.” So, for portability purposes, this term stands for the dollar amount that the surviving spouse can “port” to himself or herself.
In our example with Mary and Tom, the DSUE is $8.56mm.
Who does it affect?
So you may ask yourself, well that is a HUGE number- why on earth does this even matter?
The answer to this is simple: politics. As we have discussed, the federal estate tax exemption changes every single year and is often the subject of fierce debate. The current exemption amount of $12.06mm, is actually set to sunset back to $5mm, as adjusted for inflation, in 2025. Say Mary dies once the estate tax exemption reverts back to $5mm3, and she does NOT make a portability election to take Tom’s unused exemption amount. In such an instance, she will owe estate tax on the $5.5mm over the exemption amount in her year of death, and owe $2.2mm in ESTATE TAXES.
Furthermore, there have been talks in recent years of lowering the exemption amounts even further, to $3.5mm or less. This makes portability elections even more important, as they should be incorporated into conversations for nearly every client with net assets over $2mm, or if a client loses a spouse at a young age when they still have a significant ability to increase their net worth in future years.
What do you have to do to use it?
In order to use it, you need to file an informational IRS Form 706 for the sole purpose of passing on the deceased spouse's DSUE to the surviving spouse.4 However, the due date of an estate tax return is nine months from the deceased’s date of death (plus a 6-month extension could be obtained).
For years, many estate attorneys scrambled to file portability elections within the required time frame to enable surviving spouses to obtain the DSUE. Private letter rulings on late filings were frequently requested, which led to the IRS providing a simplified method for obtaining an extension of time for up to two years to make a portability election for estates that were not otherwise required to file a timely estate tax return.
However, the problem did not stop, and additional private letter ruling requests did not cease, which placed a burden on IRS resources. Thus, the IRS issued a Rev. Proc. that extended the timeframe for filing an informational IRS Form 706 for the sole purpose of electing portability to five years from date of death.
What is the new rule?
The new rule can be found in Rev. Proc. 2022-32. In order to successfully transfer the DSUE, the Executor/estate representative must complete and properly prepare and file an IRS Form 706 within 5 years of the deceased spouse’s death. The executor must state at the top of the Form 706 that it is "filed pursuant to Rev. Proc. 2022-32 to elect portability under Sec. 2010(c)(5)(A)."
Additionally, the deceased spouse must have been a citizen or resident of the United States on the date of death and the executor must not have been otherwise required to file an estate tax return, as determined based on the value of the gross estate and any adjusted taxable gifts. The executor also must not have timely filed the estate tax return within nine months after the decedent's date of death or extended filing deadline.
What are the deadlines extended to?
As of July 8, 2022, a portability return, assuming there was no other reason or requirement to file an estate tax return, can be filed within 5 years of the decedent spouse’s death in order to successfully transfer the deceased unused exemption amount to the survivng spouse.
1The Federal Estate Tax is a tax on property transferred by a deceased person’s estate to his or her heirs or beneficiaries.
2“Taxable gifts” are not usually what you think of when you think of a gift, so please do not go tallying up every toy given to a grandchild or check placed in a relative’s holiday card, unless it is very expensive (generall speaking, $15K or more). This is a particular type of giving that a person must report on an IRS Form 709, which is a federal gift tax return, in the the year that the gift was made.
3For argument’s sake, in this example we are going to assume that the exemption is reset back to exactly $5mm, and Mary’s assets did not appreciate in value and she died with an estate valued at exactly $10.5mm.
4Code Sec. 2010(c)(5)(A)