What You Should Know About the Estate Tax Portability Election

Revenue Procedure 2022-32

On July 8, 2022, the IRS issued Revenue Procedure 2022-32. While individual taxpayers do not normally follow announcements by the IRS, this is one you should know about if you ever worry about the size of your estate and whether it may owe taxes following your death. So, what exactly is Rev. Proc. 2022-32 and why should you know about it? Here is a summary of the key details below.

FORM 706 – US Estate Tax Return

An executor uses Form 706 to file a U.S. Estate Tax Return. Form 706 is a balance sheet of what you own and what you owe on your date of death. If your net estate exceeds the exclusion amount, the estate is required to pay a transfer tax on the assets that pass to anyone other than a spouse or a charity. The exclusion amount and rate of tax have changed significantly over the years as the chart below shows.

In this century we have fluctuated from an exclusion of $675,000 in 2001, to completely repealing the tax in 2010, to a $12,060,000 exclusion in 2022. The tax rate charged to a taxable estate has varied from 35% to 55%, exclusive of 2010 when it was 0%. What this chart tells us more than anything, is Congress is prone to changing the estate tax rules.

The chart also implies that the exclusion will keep going up, and makes it appear that very few taxpayers will ever owe estate tax. However, what the chart does not show is that the doubling of the exclusion that went into effect in 2018 under Donald Trump’s 2017 Tax Cut and Job’s Act (TCJA) is set to expire at the end of 2025. If Congress does nothing, in 2026 the exclusion amount will be in the vicinity of $6,500,000. A significantly larger number of taxpayers will have a taxable estate.

The Portability Election

Because of the high rate of estate tax, tax advisors collaborate diligently with clients to avoid this tax. However, one planning tool used to avoid estate tax is often overlooked. That tool is the portability election. When Congress reinstated the estate tax in 2011, they did so with an additional provision to help married taxpayers. The portability provision states that the executor of the estate of an individual who was married at the date of death may transfer any unused estate exclusion to the surviving spouse. This provision applies to the estates of decedents dying after December 31, 2010.

Here is an example of how portability works. First, we need to create a fictional estate with assets. The chart below discloses the assets in our estate.

Tom dies in 2020. His half of the assets are worth $6,800,000. The exclusion amount was $11,580,000 that year. Tom’s estate has no 706-filing requirement. Upon his death, all the assets go to Betty tax free. The executor decides not to file a 706 and makes no portability election.

For simplicity, I am assuming Betty spends all the income generated in 2021 and 2022 and the assets do not increase in value. Betty dies in 2022 with a taxable estate and owes estate tax as shown below.

With a portability election, the estate could have avoided estate tax completely. If an estate tax return had been filed upon Tom’s passing, the executor could have elected portability of the Deceased Spouse’s Unused Exclusion (DSUE). Since all the assets went to Betty tax free using the Bequests to Surviving Spouse deduction on jointly held property, the full exclusion from 2020 could have been passed to Betty as shown below.

Now I am changing these assumptions for further explanation. Assume that when Tom died, he left his half of the land to a trust that is not included in Betty’s estate. Betty is only entitled to the income from Tom’s land. The house and stock fund go to Betty as jointly held property. Assume Betty does not die until 2026. With the passage of six years, I am going to add an option that shows the assets increase in value.

Now I will show you the exclusion amount Tom can port to Betty when his half of the land has gone into an irrevocable trust.

If Betty lives to 2026 and Congress does extend the doubled exclusion beyond 2025, Betty would have had a sizable portion of her estate subject to tax without the portability of Tom’s exclusion. Her taxable estate would have been $4,625,000. $1,850,000 of estate tax would be owed assuming a 40% rate.

The Revenue Procedures

Taxpayers were slow to take advantage of the Portability Election. A 706 is due nine months after the date of death. A six-month extension will be granted when requested. When an estate does not owe tax, most widows or widowers were not timely filing for their spouse and making the portability election. There was not a filing requirement. However, when they went to see their advisor, the election would be discussed. If there was going to be significant benefit to making the election, the advisor would recommend a private letter ruling requesting additional time to file. Private Letter Rulings are time consuming and costly. Professional fees and the filing fee with the IRS can easily exceed $50,000. However, when taxes of millions can be saved, it was more than worth the cost.

However, the IRS was tired of answering private letter ruling requests. So, in 2017 the IRS decided to give executors a little more time to make the portability election. Revenue Procedure 2017-34 was issued June 9, 2017. It gave a simplified method to request an extension for up to two years after the date of death to file a 706 when no taxes were owed, and the filing was completed only to “port” the unused exclusion to the surviving spouse. All that was required was a disclosure on the top of the first page of the return.

The effect of the 2017 revenue procedure was to increase awareness, but it did not slow down the private letter ruling requests. Instead, advisors kept writing requests for even longer extensions. The IRS has again decided that these private letter rulings are taking too much of their time. Therefore, on July 8, 2022, they issued a second revenue procedure on this topic, Rev. Proc. 2022-32. The only change in the latest Rev. Proc. is to increase the extension for filing for portability from two years to five years.

What You Should Do

Currently, the exclusion is at a record high thanks to TCJA. Most taxpayers will never owe estate tax. However, if Congress remains gridlocked the exclusion amount will be cut in half in 2026. If you are a widow or widower whose spouse died after July 2017, you may want to reconsider whether you should have filed a 706 for your deceased spouse.

When making this decision, remember that estate taxes are usually a topic of discussion in any major tax bill. As recently as last year when President Biden proposed the Build Back Better bill, estate taxes were part of the discussion, and the proposals would have decreased the exclusion and increased the rate of tax. Ultimately that bill did not pass, and estate taxes were excluded from the last version, but no one assumes the issue will never come up again. Most advisors believe there is a good chance that estate taxes and the applicable exclusion could change again.

Filing a 706 comes with a cost, but not filing a 706 may be the biggest mistake an executor ever makes if the exclusion amount goes down in the future. If you could benefit from filing a 706, or if you would like to learn more, contact an Adams Brown tax advisor.