Estate Tax Portability: Panacea or Potential Peril? 

In 2013, Congress made the estate tax portability rules permanent. Some predicted this would negate the need for advanced estate planning, but two years later, it is clear that portability is not a panacea even for smaller estates. While it can be very useful for certain nontaxable estates, for others, and certainly for taxable estates, plans with greater flexibility remain a superior method of estate planning.

Here's how portability works. It applies only to married couples. If the first spouse to die has not entirely used his or her lifetime unified gift and estate tax applicable exclusion amount (AEA), equal to $5 million, indexed for inflation ($5.43 million in 2015), then whatever portion of the AEA that remains unused at the first spouse's death is available to the surviving spouse to add to his or her own remaining AEA. An estate tax return is filed for the first spouse's estate (even if nontaxable) under which the surviving spouse elects to "port" the first spouse's unused AEA.

Portability's benefits are primarily intended for those couples whose combined assets will remain below their combined AEAs ($10.86 million in 2015), though portability is available without regard to the size of the estate. For example, if one spouse dies leaving $2 million in assets and he has not used any of his AEA, $3.43 million of his remaining AEA is available to his surviving spouse to add to her AEA for lifetime gifting and estate planning purposes. In this example, she would add $3.43 million to her $5.43 million AEA, for a total of $8.86 million. Once portability is elected, and the deceased spouse's AEA is transferred, that amount is no longer adjusted for inflation; it's frozen. So long as the survivor's assets don't exceed $8.86 million (plus inflation for her portion of the AEA) at her death, her estate won't be subject to federal estate taxes.

Portability offers simplicity for the right couple: (a) whose assets are valued at less than their combined AEA and are not likely to appreciate beyond; (b) who have little or no risk aversion when it comes to creditors; and (c) who are not concerned about the prospect of remarriage of the survivor, in which all of the original assets could be expended on the new spouse or family. This couple can do relatively simple planning by executing wills or a revocable trust in which everything passes to the survivor outright. Portability also ensures a step-up in cost basis to fair market value of assets upon the second death, thus potentially avoiding capital gains tax upon the subsequent sale of such assets. For this reason, certain types of assets may be better suited for a portability election, e. g., a primary residence.

There are, however, several cautions to using portability as the exclusive method of planning. First, there can rarely be certainty as to all of the elements mentioned above. Second, a survivor may only use the remaining AEA of her last deceased spouse, a potential problem specifically for a younger couple. For example, if Harold predeceases Wanda, and Wanda later remarries Ted, Harold's unused AEA evaporates upon Ted's death should Ted also predecease Wanda (but note that Wanda could have used Harold's AEA to accomplish lifetime gifting before Ted's death). Third, there is no ability to port the decedent's generation-skipping transfer tax exemption to the surviving spouse, which may cause additional tax on the death of the decedent's child or children.

As illustrated, while portability is, indeed, a panacea in certain situations, it is not suited for every couple. There remain situations where traditional planning (using trusts to hold the decedent's assets for the benefit of the surviving spouse and perhaps the children) will be more advantageous and/or provide more comfort and control than the portability election. In many cases, however, drafting flexibility into an estate plan to defer the decision about portability until after the first death may be prudent where future economic circumstances and human behaviors are difficult to predict.