Why you Should Elect Portability

Clients frequently have heard of the estate and gift tax, and have heard of the high exemption amounts.  The exemption is currently at a staggering $12.06 million, higher than it has ever been.  Many clients have also learned that for a married couple can double that exemption, so they have essentially $24 million combined. With these high exemption amounts, many clients ignore the estate tax or don’t believe it will be relevant for them.

However, it is important to recognize that a surviving spouse only gets the first spouse’s exemption by electing something called “portability.”  I’m going to talk about what portability, the process of electing it, and how it is beneficial even when your assets aren’t anywhere near the current exemption amount.  The recent article “It’s So Important to Elect ‘Portability’ For Your Farm Estate” from Ag Web Farm Journal describes it as well, specifically in the context of family farms.

When one spouse dies, the surviving spouse can choose to make a portability election. This means that any unused federal gift or estate tax exemption can be transferred from the deceased spouse to the surviving spouse.  This is why the second spouse may have $24 million.  They are electing to keep the first spouse’s exemption of $12 million, and have their own $12 million exemption.   It is critical to recognize, however, that it is not automatic, and that is where most married couples make a mistake.

The process of electing portability involves filing an estate tax return with the IRS.  In most portability cases, no taxes are due, but you must file a form to obtain the exemption.  Essentially, the process involves filing the return to show the IRS what the decedent’s exemption was, and that the surviving spouse will be entitled to it in the future.  In many cases where you are only filing to elect portability, the IRS has relaxed standards for describing and valuing assets which go to a surviving spouse.  They do this because in those scenarios, they recognize you are only filing to elect portability, and that the value of assets won’t be relevant as no tax will be due.

The time frame for filing the return varies based upon the case, but you should act quickly.  The standard due date is 9 months from death, although in some cases it can be extended up to 2 years from death.  That is especially helpful where the surviving spouse didn’t speak to an accountant or lawyer after the first spouse died, and they only learn about the benefit of portability long afterwards.

Before portability was an option, spouses each owned about the same amount of assets, or the amount of assets which would use up each other’s exemptions. They would then leave as much as possible to a trust for the spouse and potentially other family members designed to use as much of the first exemption as possible, because if you didn’t use it, it was lost.  This planning made sense, but also required more complicated estate planning that got you the same result as portability does now.  Once portability arrived we were able to simplify many estate plans that no longer needed this complexity of planning.

Here’s an example. A married couple owns assets jointly and their net worth is about $14 million. When the husband dies, the wife owns everything. However, she neglects to speak with the family’s estate planning lawyer. No estate taxes are due at this time because of the unlimited marital deduction between the two spouses.

However, when she dies, she owns $14 million dollars (or more based upon growth) and dies with an exemption of $12 million.  Her estate will pay the estate tax on the difference between the exemption and her assets.  That tax bill is about $800,000.

If the wife had filed an estate tax return electing portability when her husband died, her exemption would be $24 million, and no tax would be due.

Now, I said earlier that this will apply to more than just people with $24 million dollars.  The reason is the current exemption amount is set to return to its prior level of $5 million dollar indexed to inflation in 2026.  So, let’s go through that scenario again with updated, more realistic numbers.

Husband and wife own $14 million, everything goes to the wife when husband dies and wife doesn’t elect portability.  When she dies in 2026, her exemption is $6 million (this is an estimate based upon inflation).  So, the tax will apply on the difference between her $14 million and the $6 million dollar exemption.  That is roughly $3.2 million in tax.

With the exemption as high as it is now and with the expectation of it lowering in the future, portability is critical.  If husband died when the exemption was $12 million and wife elected portability, she would get both his $12 million exemption and her own of $6 million dollars.  The combined exemption of $18 million exceeds her $14 million in assets, and no tax is due.  It saved over $3 million dollars.

Hopefully this last scenario explains how timely this is.  We raise this issue in nearly every estate administration of a married couple as electing portability now is nearly perfect insurance against future estate tax.  It is worth considering in any case where the combined assets will be close to one person’s exemption, especially where more volatile assets such as insurance, businesses and real estate are involved as the market may value them higher than expected at the time of death.

An experienced estate planning attorney can work with the family to evaluate their tax liability and see if portability will be sufficient, or if other tools are necessary.  It is also worth discussing this with an attorney if you recently lost a spouse and want to take advantage of portability.  If estate tax is a concern for you, you may also want to review this article.  https://www.galliganmanning.com/practice-areas/estate-tax-planning/  

Reference: Ag Web Farm Journal (April 18, 2022) “It’s So Important to Elect ‘Portability’ For Your Farm Estate”

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How to Claim and Use Life Insurance

Many people have life insurance, and they have it for a multitude of reasons.  These include funeral costs, liquidity in an estate, help paying off taxes and so on.  Whatever your reason for having it, I wanted to talk about how to make a claim on it, and separately, what to do with it once you have.  You can see more at Kiplinger’s recent article entitled “What Is the Best Way for a Widow to Use Life Insurance Proceeds?”

When making a claim, you’ll need a couple of things.  First and foremost, perhaps blindly obvious, is that your beneficiaries need to know you have it.  If an insurance company becomes aware of a death they might reach out to named beneficiaries, but that is a big assumption.  So, your life insurance beneficiaries or whoever may claim the insurance needs to know it exists.

Holding that aside, the person entitled to the money will start by contacting the insurance company.  The company will send or direct that person on where to download a form to claim the insurance.  Beneficiaries typically need to provide proof of who they are, a death certificate for the insured (which in most places is issued within a few weeks of death) and other information about how to pay the insurance.  For example, some companies ask if you want to turn it into an investment fund at their financial institution, others arrange how to cut the check and so on.

It is worth noting that your executor or trustee won’t have the right to do this unless the estate or the trust is the beneficiary of the life insurance.  All told, the process typically takes something like 30 days.

Now, what to do with the insurance proceeds varies based upon the purpose and need of the life insurance.  I’m also going to assume for now that the insurance isn’t being paid to a trust which is designed to hold assets long term such as a descendant’s trusts.  That might have different concerns.

So, with that said, here are some ideas on how to use the life insurance.

Funeral Costs. Use life insurance money to cover these costs to decrease your financial strain.  Most funeral companies actually have you purchase a small insurance policy in order to prepay a funeral.

Ongoing Expenses. This is especially true when one spouse dies, but living expenses do not stop. Your income is frequently reduced. In fact, after the death of a spouse, household income generally declines by about 40% due to changes in Social Security benefits, spouse’s retirement income and earnings. The death benefit from a life insurance policy can help provide the funds you need to help cover your mortgage, car payment, utilities, food, clothing and health care premiums.

Debts. You are generally not personally responsible for paying off the debts of the decedent. However, when an estate does not have enough funds to pay all the debts, any gifts that were supposed to be paid out to beneficiaries will most likely be reduced. Note that you may be responsible for certain types of debt, such as debt that is jointly owned or a loan that you have co-signed. Talk to an experienced estate attorney to understand the laws of your state, so that you know where you stand concerning all debts.  By way of example, you have very few responsibilities to pay a decedent’s debts in Texas.

Taxes.  As a tie-in to debts, some people use life insurance to give an influx of liquidity to pay estate taxes.  This often helps when an estate is large due to real estate or businesses or other illiquid assets.  The IRS of course wants the tax paid in cash, so life insurance gives you the cash to do so without liquidating other assets.

Create an Emergency Fund. Life insurance can help build a liquid emergency fund, which should cover three to six months of expenses.

Supplement Your Retirement. When one spouse passes, the survivor becomes much more economically vulnerable. To retire, a person typically needs 80% of their preretirement income to live comfortably.  So, insurance provides and extra supplement to cover that need.

Reference: Kiplinger (Dec. 17, 2021) “What Is the Best Way for a Widow to Use Life Insurance Proceeds?”

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Update on Estate and Gift Taxes for 2022

There was a lot of discussion last year about potential changes to the federal estate and gift tax laws.  It’s possible that some of these proposals may be enacted in 2022, but for now, none of them have passed.  In the meantime, exemptions have increased for inflation, giving taxpayers a chance to lock in rates and exemptions before the federal estate tax sunsets to $5 million and some “change” for inflation. You can see a fuller explanation in the recent article, 2022 Transfer Tax Update,” from Forbes.

For now, the increased estate and gift tax exemptions are:

  • In 2022, $12,060,000 federal estate tax exemption, with a 40% top federal estate tax rate.
  • $12,060,000 GST tax exemption and a 40% top federal GST tax rate.
  • The lifetime gift tax exemption is now $12,060,000; with a 40% top federal gift tax rate.
  • The annual gift tax exclusion for 2022 increases to $16,000.

The IRS and the Treasury Department have both stated they will not attempt any claw-backs from gifts given between 2018—2025 for a taxpayer who dies in 2026 or beyond, when the exemptions return to the $5 million mark under the 2012 Act.

The opportunity to take advantage of these exemptions is now. A variety of estate planning techniques are still available to address estate and gift tax. Shifting income-producing assets to individuals in lower income tax brackets or who live in states with no or lower income taxes may be appropriate.  It might make sense to make substantial gifts in 2022, but that will be a case by case analysis.  You can see this past article discussing that more, although it should be tempered by the current tax picture: https://www.galliganmanning.com/gifting-and-estate-taxes/  

Does this mean your estate plan needs to be revised? If you’re like most people, your estate plan is relatively flexible. However, if you haven’t reviewed or revised your estate plan in two or three years, it’s time to make an appointment with your estate planning attorney. There have been many changes in the law in recent years, and chances are, changes in your life since the last time your plan was reviewed.

The GST tax is not portable on the death of a spouse. Certain states (including New York, Connecticut, and Massachusetts) don’t permit estate tax exemption portability. A bypass trust may be the solution.

The gift tax annual exclusion amount has increased to $16,000 for individuals ($32,000 by married couples). It may be better to gift securities of interests in privately held companies or other family entities. Assets gifted now may be worth less than they were previously, and if they increase in the future, you’ve created a built-in discount.

Talk with your estate planning attorney to make the most out of these tax situations before they go away.

Reference: Forbes (Jan. 4, 2022) 2022 Transfer Tax Update”

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