Financial advisers who want to maximize a wealthy client's tax-free estate have a simple yet often overlooked strategy handy that essentially doubles the amount avoiding taxation at death.
The strategy, called portability, applies to married couples. When one spouse dies, portability allows the surviving spouse to inherit the decedent's estate-tax exemption, which is currently $11.4 million for individuals.
The surviving spouse would therefore be able to shield $22.8 million from the 40% federal estate tax when it passes to heirs upon death, instead of $11.4 million.
"It doubles the amount you can pass on estate-tax free," said Charlie Douglas, who runs an Atlanta-based family office.
The strategy could save clients a bundle of money. Consider a married couple with a $16 million estate, split evenly between a husband and wife. If the husband dies first and there's no portability, the estate would owe federal tax on $4.6 million of the estate when the wife dies ($16 million minus the wife's $11.4 million exemption). That amounts to a $1.84 million tax bill. With portability, however, the estate wouldn't owe any tax — due to the wife's $22.8 exemption.
But clients must file tax form 706 within nine months of the first death in order to elect portability. (There's also a six-month extension to file.) Despite the benefits, advisers and clients often forget to take this step, said Ed Slott, founder of Ed Slott & Co.
"I don't think they address it until it's too late," he said.
Portability was codified by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. Prior to that, clients could only pass on their estate-tax exemption by using credit shelter trusts.
The 2017 tax law vastly increased the amount an estate can pass on tax-free — the exemption doubled to $11.18 million in 2018 from $5.49 million the prior tax year.
Many advisers may be unconcerned about portability given the current higher thresholds, since only the extremely wealthy will owe federal estate tax. However, the thresholds are set to revert in 2026 — which would cut them in half again. This impending change gives advisers added reason to pay attention more now than in the past, experts said.
"That changes [the calculus] a bit," said Mr. Douglas. "[Portability] is one of those sleepy things at the moment for all but the uber wealthy. But I think for the moderately wealthy, somewhere between $5 million and $10 million, it might make some sense to look at portability."
Plus, there's reason to elect portability even if an estate wouldn't currently be taxable.
"You don't know what [the exemption] might be in the future," Mr. Slott said. "What if you live 30 years and [the deceased spouse] left you just $1 million or $2 million, but in 30 years it's worth $50 million? You don't know what it might appreciate to. Why not lock it in? It's a freebie."