What The Heck Is Portability?

Note: This is the first of two installments on a new tax planning strategy for married couples.. In recent years, a new estate tax planning strategy has become available for married couples.  Known as “Portability”, it was first added by the federal tax law that became effective in 2011 that, among other things, extended the so called “Bush tax cuts” through 2012.  Another law that further extended some of the “Bush tax cuts” indefinitely and avoided the “fiscal cliff” was signed into law by President Obama in 2013.  It made the “Portability” concept a permanent part of the tax code effective 2013.  Recently, the IRS has finally issued new regulations to implement the new law. The Background To understand the Portability concept, we first must review some basic estate tax law.  In short, each taxpayer gets a “coupon” that allows him or her to pass on assets below a certain level to their designated beneficiaries without having to pay the so-called “death tax”.  The coupon’s value changes as new tax laws are enacted.  Under the 2013 law mentioned above, the coupon is tied to an inflation index. For 2016, it is $5.45 million per person. With effective estate tax planning, a married couple can double that amount to $10.9 million in 2016. Before Portability, that effective planning generally required that a married couple’s estate plan include a formula by which the couple’s assets could be divided into two or three separate trusts upon the death of the first spouse to die.  This is often referred to as A-B or A-B-C Trust planning.  While an effective tax saving procedure, it does add an administrative burden to the surviving spouse since he or she has to maintain two or three trusts.  In addition, access to the assets in one of the trusts by the surviving spouse must be restricted according to certain legal standards Along Comes Portability While the reasoning behind Portability is that it is intended to simplify estate tax planning, like many tax concepts it is, in fact, potentially complex in application. In short, Portability basically means that, if the first spouse dies and the value of the couple’s total estate does not require the use all of the deceased spouse's “coupon”, then the amount of the coupon that was not used for the deceased spouse's estate can be transferred to the surviving spouse so that he or she can use the deceased spouse's coupon in addition to his or her own coupon when the surviving spouse later dies. Portability in Action As noted above, prior to the availability of Portability, married couples sometimes had to divide their assets into two or three trusts to effectively use their “coupons”.  This led to complaints about complexity, cost and other burdens. With Portability, many of these issues are avoided as no “subtrusts” are needed.  To invoke Portability, one must timely file an Estate Tax Return (Form 706) in which Portability is elected.  Typically, that Return must be filed within nine months after the death of the first spouse to die. In the next installment, we will discuss some pros and cons of this new planning option.