How to benefit from the inheritance tax portability clause
Due to recent tax law changes, the estate of a wealthy individual may be sheltered from federal tax with a generous $10 million estate tax exemption, subject to the indexation to inflation. The indexed figure is $12.06 million for those who died in 2022. Additionally, transfers between spouses remain fully tax exempt under the unlimited spousal deduction. Therefore, most people do not need to worry about federal estate tax.
However, the estate tax exemption is expected to revert to $5 million in 2026, indexed to inflation. Fortunately for married couples, the exemption is “transferable” by law. In other words, the estate of the second deceased spouse can benefit from any unused portion of the exemption that the first deceased spouse can benefit from.
As a result, a married couple can effectively transfer up to $24.12 million in 2022 without paying a dime in inheritance tax!
How it works: The portability election – officially called the “Deceased Spouse Unused Exemption” (SDUE) election – is claimed by the executor of the estate.
The easiest way to explain the election of the EUSD is to look at a hypothetical example.
Suppose Jane and John, a married couple, have two children. Each spouse individually owns assets valued at $5 million and they have $10 million jointly with rights of survivorship. Thus, their total assets are valued at $20 million. According to their wills, all property passes first to the surviving spouse and then to the children.
If John dies in 2022, the $5 million in assets bequeathed to Jane are exempt from the estate via the unlimited spousal deduction. Thus, the entire exemption of $12.06 million is unused. However, if the election is made upon his death, Jane’s estate can later use the $12.06 million EUSD for John, plus the exemption for the year of his death, to protect the $7.94 million. of remaining tax dollars, with plenty to save for appreciation in value.
What would have happened without the portability provision? For simplicity, let’s say Jane dies later in 2022. Without being able to benefit from John’s unused portion of the exemption, the $12.06 exemption for Jane in 2022 leaves $7.94 million subject to tax. on successions. At the 40% rate, the federal estate tax bill would be $3.176 million.
Although techniques such as a traditional bypass trust can be used to avoid or reduce estate tax, you can see how choosing the DSUE can be a valuable tool in your estate planning toolbox. Advance planning can help you achieve your goals.
Reminder: Depending on your situation, there may be other considerations, including the creation of creditor protection trusts. Remember that portability is not the be-all and end-all. But this provision can be the ceiling of the foundations of your estate plan.