What Portability Can (and Can’t) Do for Your Estate Plan

As the economy continues to recover, many families in agribusiness, food processing, and related industries are finding the value of their respective estates increasing. In some cases families have received lifetime gifts or an inheritance; in others the value of agriculture property the family holds has risen or business is simply booming. Regardless, with a larger estate comes the need for effective estate planning. A federal law passed in 2012 made permanent a provision for estate “portability,” an important planning tool for some estates. Let’s look at what portability is, how it can provide backup to your estate plan, and a few other considerations to weigh when you’re developing your estate plan.

Overview: How Does Portability Work?

Under federal estate tax law, estate holders can exclude $5.34 million each ($10.68 million for couples) in 2014. If you leave a larger estate, any amount beyond the threshold will be subject to federal estate tax. Congress could, of course, revise the legislation at any time.

The portability election provides that when one spouse dies, any individual estate tax exclusion not otherwise used by the deceased spouse can be transferred to the surviving spouse. To elect portability, the executor of the estate must file federal IRS Form 706 and make the election within nine months of the deceased spouse’s death (or the form’s extended due date, if applicable). Portability is not automatic. There is relaxed reporting relief for certain estates that are not otherwise required to file federal Form 706.

To illustrate how portability works, let’s look at a simple example. Say a husband and wife have a combined estate of $11 million. The husband holds $8 million as separate property, and the remaining $3 million is held as community property. The wife passes away. Half of their $3 million in community property—$1.5 million—makes up her estate. She passes the $1.5 million on to her heirs as directed by her will, using up that much of her federal estate exclusion amount. But since the potential individual estate tax exclusion amount is $5.34 million, there is an additional $3.84 million she could have excluded had her individual estate been larger. If her executor elects portability, her $3.84 million in unused exclusion will transfer to her husband and be added to his own individual estate exclusion amount. This results in a total of $9.18 million in estate exclusion available at his death.

It’s important to note that lifetime gifting (above the annual gift exclusion amounts) does count against the available federal estate exclusion amounts. Going back to the example above, assume the wife had gifted $1 million to her heirs over the course of her lifetime. When she dies, leaving the same $1.5 million estate, only $2.84 million in remaining exclusion is available to pass to her husband for a total of $8.18 million excludable at his death.

Advantages and Disadvantages

Individuals with taxable estates over the federal exclusion amounts will want to consider estate planning beyond what portability can offer them. Those with estates under the exclusion thresholds may, however, be thinking that portability alone has their estate taken care of. But like all estate planning tools, portability offers both advantages and disadvantages. Advantages include:

  • Simplification. The biggest advantage to using portability is that it simplifies estate planning and the administration of the estate by the executor. Using portability may make a trust unnecessary for holding the deceased spouse’s assets, thereby providing the surviving spouse with more control of the assets. 
  • Step-up in basis. Portability allows for the heirs to receive a “stepped up” basis for all assets that are received upon the surviving spouse’s death, since the assets are later includable in the surviving spouse’s estate. The result is a potentially reduced capital gains tax upon their future sale—a valuable planning opportunity as income tax rates for wealthy individuals rise (and particularly when figuring in the new Medicare surtax).
  • Retirement plan rollover advantage. Portability can present a major advantage if the deceased has a large retirement plan. With portability, those with large retirement plans are more likely to leave them outright to their surviving spouse and retain the spousal rollover as a viable planning option.

On the other hand, portability by itself can do only so much—and it comes with some drawbacks that more detailed estate planning can better address. For example, portability:

  • Doesn’t protect against volatility in legislation. Though the exclusion amounts are permanently indexed for inflation and the gift and estate tax rates have been set, Congress could enact new legislation at any time to generate more tax revenue. Assets that have been transferred to a surviving spouse via outright bequest—whether portability has been elected or not—will be subject to future changes in the estate tax law, whereas assets transferred into a bypass trust at the first spouse’s death will likely be protected against any future changes in the estate tax law upon the surviving spouse’s death.
  • Adds to the taxable estate of the surviving spouse. When an estate passes directly to a surviving spouse, any future appreciation continues to grow in the surviving spouse’s estate, creating a larger estate tax issue for that individual down the road.
  • Offers no asset protection. When an estate’s assets are passed directly to a surviving spouse, they’re incorporated into the surviving spouse’s own assets. While this provides the surviving spouse with more control over those assets, it also means the assets are subject to the survivor’s creditor claims and claims situations that may arise in blended families (such as by a future spouse of the surviving spouse, upon a future divorce, or by the children of a future spouse).
  • Can get complicated when combined with state estate taxes. Some states have their own estate or inheritance tax system; the state exemption thresholds may be lower than the federal exemption thresholds, or the state may disallow the portability provisions. Depending on the state you reside in and states where you own property, the portability election may significantly impact your estate planning.

Planning Beyond Portability

Even if you and your spouse each have individual estates under $5.34 million, consider an inheritance structure such as a credit shelter trust rather than relying solely on portability. When a deceased spouse’s estate passes into a trust rather than to the surviving spouse, the assets can be protected from creditors, remarriage, and the possibility of divorce settlements. They can also be protected from federal estate tax on further appreciation. The assets grow in the trust rather than the surviving spouse’s estate, and since the trust is likely to have multiple beneficiaries, its eventual tax implications can be distributed across several individuals instead of falling on just one.

Consider the role of lifetime gifting in your estate planning strategy as well, particularly if you will pay estate tax to a state where the exclusion threshold is much lower. Washington State is a prime example of how lifetime giving can play a critical role in an estate plan; Washington does not tax lifetime gifts, and though the state’s estate tax exclusion threshold is much lower ($2 million), the state does not bring lifetime gifts back into an estate at the time of death. As a result, lifetime gifts permanently escape Washington estate tax.

If your and your spouse’s estate is over the combined exclusion threshold, it may also be worth looking at charitable giving, which can reduce the amount of your taxable estate and provide you with a charitable deduction.

We're Here to Help

Many families in food processing and agribusiness are owners of closely held businesses and will one day want to transition ownership to a new generation. If this is true of your business, look at your estate plan in conjunction with your business succession plan. Estate plans can be complex—often requiring the involvement of attorneys, insurance agents, and bankers as well as your CPA—so it’s a good idea to get started as soon as your estate value begins to near the federal exclusion amounts or those of your state. Additionally, keep in mind that the improper titling of your property can break an estate plan. It’s important to work with all of your advisors to develop a plan and implement it properly.

For more information on estate planning and related business succession planning, contact your Moss Adams professional.