If your family has significant wealth, it’s now easier to avoid federal estate taxes, thanks to recent changes from the IRS.
The IRS improved a strategy known as “portability,” used by high-net-worth married couples expecting to owe federal estate taxes when the second spouse dies.
Here’s how it works: While a spouse may inherit all of their partner’s assets tax-free, estate taxes may be owed after the surviving spouse passes, depending on the total value.
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In 2022, there’s a $12.06 million exemption per person for gifts and estate taxes, meaning you won’t owe federal levies for giving away $12.06 million or less to your children or other non-spouse beneficiaries during life or at your death. You may owe up to 40% estate taxes on anything above that.
But the surviving spouse may elect portability, allowing them to have their partner’s unused exemption along with their own, explained certified financial planner David Silversmith, a CPA and senior manager of PKF O’Connor Davies in Hauppauge, New York. That means the couple could gift $24.12 million before estate taxes kick in.
Previously, surviving spouses had two years from their partner’s death to elect portability, but the latest IRS change extends the deadline to five years, he said.
Another change: If you’re within the five-year window, you’ll no longer need to request guidance from the IRS, known as a private letter ruling, said Michael Whitty, a CFP practicing as an estate planning attorney at Freeborn and Peters in Chicago.
You can elect portability within the five-year period by filing an estate tax return. “That’s incredibly simple, so it makes it almost a no-brainer,” he said.
An estate tax return may cost anywhere from $5,000 to $20,000, or more, depending on the complexity and where you live, Whitty said. “But when you compare that to saving 40% on every million dollars of the portability exemption, it’s pretty compelling.”
What’s more, while the current $12.06 million exemption will adjust for inflation through 2025, the exemption drops by roughly one-half in 2026 when provisions sunset from the Republican’s 2017 tax legislation. Whitty estimates the exemption will drop between $6.5 million and $7 million.
“It’s potentially very, very significant,” said Kevin Matz, partner in ArentFox Schiff’s private clients, trusts and estates group in New York, noting that many more estimates may be affected.
When a loved one dies, heirs file a Form 1040 for a final tax return, along with Form 1041 for any income earned by the estate in the year of death. Some families also file Form 706 for estate taxes.
However, if your estate and lifetime gifts are below the $12.06 million exemption for 2022, you’re not required to file a federal estate tax return. But experts say it still can be beneficial for certain high-net-worth families.
Matz said it may be risky for wealthy families to skip an estate tax return, especially with harder-to-value assets, such as certain types of businesses.
You may believe the first spouse’s wealth is below the threshold, but if the IRS questions the estate valuation later, it may block the second spouse from taking full advantage of portability, he said.
“That would be a very bad result produced by not seeking professional advice,” he said.