Portability Elections: Update

A month ago I wrote a blog on portability, which is an estate tax concept in which a surviving spouse keeps the estate tax exemption of the deceased spouse.  That blog focused on what it is and its potential tax advantages for families.  See here for that article:  https://galligan-law.com/why-you-should-elect-portability/  

Incredibly, the IRS published a revenue procedure last Friday extending filing deadlines for estates which only need to elect portability to 5 years after death.  The time limit had been 2 years.

Previously, the IRS would consider an extension beyond the 2 year limit in private letter rulings.  Essentially, you could write to the IRS explaining why you would need more time or were unable to complete the return in 2 years, and the IRS would consider an extension.  Portability is sometimes so critical that many, many individuals made private letter requests for extensions past the 2 years.  The IRS indicated they received so many letter request that it placed a “significant burden” on IRS resources, so much in fact that the IRS extended the deadline to avoid the need for those letter requests.

You can find the full revenue procedure here:  https://www.irs.gov/pub/irs-drop/rp-22-32.pdf

Now, it is important to recognize this only changed the deadline for returns that are only filed for portability purposes.  If the decedent had sufficient assets so that a return was required (i.e. their assets met or exceeding their exemption), then it remains due within 9 months of death and not filing timely or paying timely could have serious consequences.  Accordingly, in all cases going forward you should assume the deadline in 9 months, but may have the option of up to 5 years.

The immediate advantage of this rule is it gives us more hindsight.  If you or someone you know lost a spouse in the last 5 years and they did not file an estate tax return, it might be worth considering.  Many people didn’t do this a few years ago because the exemptions were high.  They assumed that if the survivor’s exemption was going to be, say $10 million, then portability wouldn’t be necessary and they didn’t take steps to elect it.

However, currently Congress has not changed the estate tax law.  The exemption is still set to cut in half in 2026.  Further, COVID has disrupted the economy in a way that has negatively affected the market, but also lead to substantial growth in some industries and for some individuals.  So, whereas portability might not have seemed prudent 6 months after the death of a loved one, it might seem so 3.5 years after the death of a loved one.  Thanks to this new procedure, filing for portability is still possible.

Similarly, if you were in charge of an estate, either as an executor, administrator or trustee, it might be worth considering doing this as a prudent discharge of your duties. It would potentially assist a surviving spouse and ultimately lead to less tax for the family, and will avoid questions from beneficiaries about why you didn’t do it in the first place.

You can find the full revenue procedure here:  https://www.irs.gov/pub/irs-drop/rp-22-32.pdf

 

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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://galligan-law.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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What If You Don’t have a Will?

Studies suggest that a majority of adults do not have an estate plan of any kind, even a will.  The issue of what happens when a person doesn’t have a will comes up frequently in our practice.  The answer to the question, which is what I’ll discuss here, provide lots of reasons to have one.  You can see a recent article entitled “Placing the puzzle pieces of long-term care and planning a will” from the Pittsburgh Post-Gazette for a bit more background, although state processes vary.

First, a will is a written document stating wishes and directions for dealing with the property you own after your death, also known as your “estate.” When someone dies without a will, property is distributed according to their state’s intestacy laws.  Intestacy sets who your beneficiaries will be since you haven’t chosen them, and generally are next of kin (with some wrinkles). If your next of kin is someone you loathe, or even just dislike, they may become an heir, whether you or the rest of your family likes it or not. If you are part of an unmarried couple, your partner has no legal rights, unless you’ve created a will and an estate plan to provide for them.

Intestacy rules vary greatly from state to state, especially in a community property state like Texas.  In general, intestacy laws distribute property to a surviving spouse or certain descendants. A very common exception, which many people don’t know and are surprised to learn, is that if you have children from outside of the current marriage, not everything goes to that spouse.  I frequently encounter families who assume spouse gets everything, regardless of family makeup, and this often leads to conflicts with family.

While practicing in Pennsylvania I actually had a situation in which one spouse died young without children and with living parents.  Not everything goes to the spouse in that situation, but instead, partially to spouse and the rest would have been divided between the surviving spouse and parents.  The surviving spouse was not pleased to learn that.

This may also lead to a difficult result for the beneficiary.  If they have disabilities and are using government benefits, receiving the inheritance may cause them to lose those benefits, which may be critical for that person’s care.  Wills and other estate planning documents can prevent that outcome.

If you don’t have a will, at least in Texas, it may be necessary to have a proceeding to determine who the heirs even are.  This is called an heirship proceeding and can be quite expensive as the court appoints another attorney (who you pay) to look for unknown heirs.  This whole process also adds time and uncertainty to a process which is already difficult due to the loss of a loved one.

Additionally, a will designates a person to handle the estate, often called an executor, and typically names successors should the first named person be unable or unwilling to serve.  In the absence of these directions, the heirs will have to figure it out among themselves, hopefully amicably and without litigation.

Many states also have limited proceedings that may or may not be helpful when a person doesn’t have a will.  For example, Texas has affidavits of heirship which can address retitling of land interests, such as the residence.  However, that won’t help for bank accounts.  Pennsylvania actually has a rule permitting small bank accounts to be distributed to next of kin after the funeral is paid.  That too may help, unless the account is $10,000 and is useless for land.  Many states have small estate proceedings that can work, but in practice are often cumbersome.

A much better solution: speak with an experienced estate planning attorney to have a will and other estate planning documents prepared to protect yourself and those you love.

Start by determining your goals and speaking with family members. You may be surprised to learn an adult child doesn’t need or want what you want to leave them. If you have a vacation home you want to leave to the next generation, ask to see if they want it. It may reveal new information about your family and change how you distribute your estate. A grandchild who has already picked out a Ferrari, for instance, might make you consider setting up a trust with distributions over time, so they can’t blow their inheritance in one purchase.

Determining who will be your executor is another important decision for your will. They are a fiduciary, with a legal obligation to put the estate’s interest above their own. They need to be able to manage money, make sound decisions and equally important, stick to your wishes, even when your surviving loved ones have other opinions about “what you would have wanted.”  See this article for further ideas:  https://galligan-law.com/what-are-the-duties-of-an-executor/  

If there is no one suitable or willing, your estate planning attorney will have some suggestions. Depending on the size of the estate, a bank or trust company may be able to serve as executor.

The will is just the first step. An estate plan includes planning for incapacity. With a Will, a Power of Attorney, Medical Powers of Attorney and other documents appropriate for your state, you and your loved ones will be better positioned to address the inevitable events of life.

Reference: Pittsburgh Post-Gazette (April 24, 2022) “Placing the puzzle pieces of long-term care and planning a will”

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