Holding Court is a series by retired Rye City Court Judge Joe Latwin. Latwin retired from the court in December 2022 after thirteen years of service to the City.
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By Joe Latwin
In 2026, the federal estate tax exclusion is set to increase to $15 million per person, allowing individuals to transfer this amount free of federal estate, gift, and generation-skipping transfer taxes. It is indexed for inflation after that. Anything over that could be taxed at 40%. But for married couples, each spouse might benefit from both spouse’s individual $15 million exclusion if they play their cards right. Done right, a couple could exclude up to $30 million dollars from their estates. However, to obtain the full benefit of both exclusions, there is a strict set of rules that must be followed. A recent case from the U.S. Tax court pointed out how not following the rules could be an expensive mistake.
The wife died a few years before her husband. The husband’s executor filed an estate-tax return for the husband’s estate. Upon review of the husband’s estate tax return, the IRS reviewed the wife’s estate tax return and found it incomplete, and IRS disqualified the husband’s estate from getting the unused portion of the wife’s exclusion. The Tax Court sided with the IRS disallowing the husband’s estate from using the common planning technique known as portability.
In general, there is no requirement to file an estate-tax return when the first spouse dies if the estate isn’t above the threshold. When one spouse dies, the surviving partner often inherits all or part of the deceased spouse’s estate. The surviving spouse receives those funds tax-free. The survivor can also carry over the deceased’s unused estate tax exclusion, so the survivor’s estate gets a bigger tax shelter. This is called “portability. Portability allows a surviving spouse to use any leftover exclusion amount from the first spouse to die—as long as the first to die’s estate filed a return and properly opted for portability. This is sometimes overlooked since property passing to a surviving spouse is not considered in determining estate taxes for the first to die spouse due to the belief that since no taxes are due, the filing of an estate tax may not be necessary or advisable. The issue will then lie dormant until the second spouse dies by which time it can be too late to fix any mistakes.
In the case, the wife had an unused exclusion amount of $3.7 million because of the failure to elect portability on the wife’s estate tax return. That amount was not excluded from the husband’s estate and caused his estate to incur extra taxes of $1.48 million dollars. Obtaining the doubled estate tax exclusion for married couples isn’t automatic.
Since estates are taxed at 40%, the heirs of a couple that loses the $15 million exclusion for the first spouse would owe an extra $6 million in taxes.
For most surviving spouses, a $15 million exclusion is enough to shelter their estates from taxes. They don’t need the combined $30 million available to a married couple. Nearly 500,000 Americans have a net worth of $15 million or more. Hopefully, you are among them. For those with estates worth $15 million to $30 million, it generally makes sense to file an estate-tax return when the first spouse dies to elect portability. Even those with less than $15 million today might need the first spouse’s extra exclusion amount later on. Their investments could grow, or they could get an unexpected inheritance or win the lottery.
The concern for families and their advisers is how much of a mistake can be on an estate-tax return filed for portability before the IRS considers it defective.
