Overlooking the need to elect portability is a common mistake—and one that can lead to the loss of valuable estate tax savings down the road.
Because of the generous federal estate tax exemption, most upper middle class clients understandably fail to realize the need for making a portability election in order to preserve the portability option for the future. Fortunately, the IRS has provided relief for certain clients who have failed to make a timely portability election (typically without the need for an expensive private letter ruling)—but for many clients, advisors need to remain vigilant in ensuring that the need for making a portability election is even on the client’s radar following the death of a spouse.
The Portability Rules
Portability simply allows a surviving spouse to make use of both his or her individual federal estate tax exemption and the exemption granted to a first-to-die spouse. Because every decedent is allowed an exemption of $5.49 million in 2017, this allows a married couple to shelter a combined $10.98 million from any federal estate tax liability.
This generous estate tax exemption, however, can often cause a problem for surviving spouses when the entire estate of the first-to-die spouse is sheltered from estate tax. Clients and advisors alike commonly overlook a key requirement for obtaining the benefits of portability: you have to ask for it. Even if no estate tax is due upon the death of a first-to-die spouse, the executor of the estate must elect portability by filing an estate tax return on Form 706 within nine months of death.
Failure to make the election can eventually cause the estate of the second-to-die spouse to bear the entire tax burden, especially because the surviving spouse often inherits the bulk of a deceased spouse’s estate, thereby increasing the value of his or her own estate. While many clients may believe that the value of their estate could never exceed the $5 million mark, they may be overlooking the fact that the value of the first-to-die spouse’s estate will be included in—and potentially taxed with—their own eventual estate.
The Good Cause Extension
As discussed above, for a client who is not otherwise required to file a federal estate tax return because his or her estate does not exceed the federal exemption amount, failure to elect portability is common. The election could still be valuable, however, in the case of a lower estate tax exemption in future years or if the client’s estate grows substantially in the years between the death of the first spouse and the client.
IRS officials have released a statement reminding estates that have failed to make timely portability elections that extensions may be available if the estate can show that there was good cause for the failure. If the estate was originally required to file an estate tax return (generally because the value of the estate exceeded the annual exemption amount), no extension for electing portability is available.
However, many estates that were otherwise not required to file an estate tax return fail to elect portability on time (by filing an estate tax return within nine months following the decedent’s death; an automatic extension to 15 months is available) and those estates may be eligible to request an extension.
The extension is requested by filing Form 4768, and the IRS advises taxpayers to include on this form an explanation for why they had good cause for failing to meet the deadline (the client will also be required to file Form 706).
Common “good cause” excuses are that the taxpayer relied on a qualified tax professional’s advice that no portability election was necessary or that, given the taxpayer’s experience and the complexity of the issues, the client was unaware of the need for making the election after exercising reasonable diligence. Relying on written IRS guidance or discovering the error and requesting relief before the IRS discovers the error also qualify as good cause excuses.
The IRS’ reminder on the potential for late portability elections highlights the advisor’s role in ensuring that the client is aware of the potential value of electing portability—even in situations where the estate of the first-to-die spouse does not exceed the federal estate tax exemption amount—in order to preserve the portability option for the future.