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Portability & Estate Tax: What it is and why it's important?

Colorado does not levy a state tax on your estate and the federal estate tax exemption is currently $5.49 million per individual in 2017, so why consider filing an estate tax return? Portability. This provision in the tax code allows for the transfer of any unused portion of the exemption to a surviving spouse.

What many do not fully understand is that this transfer does not occur automatically. To carry over a deceased spouse's unused portion of the exclusion (DSUE) you have to tell the IRS you want this after the first spouses passes away. The deadline to request estate and gift tax portability has recently been extended from nine months to two years. In this post, we will offer an example to illustrate how portability works.

What is included in an estate?

A first concern might be that there is no way your estate will surpass the federal exemption. Here are some of the assets that are considered when determining the value of an estate for tax purposes (a few categories taken off IRS Form 706):

  • Real estate (a family home, vacation property or investment property)
  • Stocks and bonds (potentially owned in an IRA or municipal bonds other investment account)
  • Mortgages, notes and cash (a loan to a relative at a lower interest rate or gold coins purchased to weather recession)
  • Miscellaneous property (the collector '57 Corvette or artwork from a well known Western artist or an up-and-coming artist drawing a following).

Some of the assets that make up an estate may appreciate beyond expectations. Real estate in the Cherry Creek neighborhood continues to soar in value. Or your home may be needed for a commercial development and all of a sudden the value is based solely on the size of the property.

An example of what can go wrong

The estate tax is a flat tax of 40 percent on estate assets above the exclusion, so properly planning for and utilizing the estate and gift tax exclusion is important. It's also impossible to predict how long a surviving spouse will live and what will happen in the intervening years.

Here is what can go wrong: Jim, a successful business owner, passes away and leaves $4 million to his wife Leslie. No one ever files for the DSUE and when Leslie dies the estate is valued at $9.5 million and her estate must file and pay federal estate taxes. By planning ahead, this surprise could have been avoided when the surviving spouse dies. 

If this portability election was not made and a spouse passed away between 2011 and 2015, the IRS may grant relief through January 2, 2018. In the future, it will be a two-year deadline. Missing the two-year deadline will require a private letter ruling through the IRS to elect portability.

This is a complex area where taxes and estate planning intersect. These rules have been known to change over time, so it is important to meet with an experienced attorney for a regular review of an estate plan and for guidance after the death of a loved one.

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