Journal of Financial Planning: December 2017
Randy Gardner, J.D., LL.M., CPA, CFP®, is the head of financial and fiduciary education for Horace Mann, the largest multi-line insurance and financial services company focused on educators’ needs.
Leslie Daff, J.D., is a state bar certified specialist in estate planning, trust, and probate law, and the founder of Estate Plan Inc.
Estate planning news flash: if the estate tax is not repealed by Congress, the inflation-adjusted amount of the gift and estate tax exclusion in 2018 will be $5.6 million, and the gift tax annual exclusion will increase to $15,000.
This article summarizes four important recent developments regarding the portability exclusion, including the opportunity through Jan. 2, 2018 to make the election for any decedent who died after 2010.
The Opportunity
Portability is probably the most important post-mortem election available to a surviving spouse. However, many advisers working with surviving spouses chose not to make the portability election because they did not foresee the assets growing to a level that would trigger estate tax. The table on page 31 puts this decision into context.
The table assumes the 2018 exclusion amount will increase at a 2 percent rate, the surviving spouse’s net worth will increase at 6 percent, the surviving spouse will spend $150,000 per year for living expenses (increasing at a 2 percent rate each year), and make two annual exclusion gifts each year.
In other words, a couple in their 50s with $2 million of assets when the first spouse dies may be subject to estate taxes if the survivor lives another 29 years.
If the table makes you think that maybe you should have filed an estate tax return (Form 706), making the portability election for a client who died since 2010, the IRS is allowing you another chance to file a return.
Through the later of Jan. 2, 2018, or the second anniversary of a decedent’s date of death, Rev. Proc. 2017-34 provides a simplified method for taxpayers who were not required to file an estate tax return to obtain an extension of time to make a “portability” election without having to pay a $10,000 fee for a private letter ruling.
If the revised computation of the surviving spouse’s applicable credit amount would result in a credit or refund of the surviving spouse’s gift or estate tax, the availability of the simplified method during the two-year period may reduce the risk that the period for filing a claim for that credit or refund will expire. Generally, taxpayers have three years from the date of filing, or, if later, two years from the date of payment to file a claim.
The simplified method is available to the executor of the estate of a decedent if the decedent was survived by a spouse, died after Dec. 31, 2010, and was a citizen or resident of the U.S. on the date of death. Furthermore, the executor could not have been required to file an estate tax return which was not filed. If the executor did file a return and opted out of the portability election, the executor cannot now change the return.
Example: Predeceasing spouse (S1) dies on Jan. 10, 2015, survived by surviving spouse (S2). The assets includible in S1’s gross estate consist of cash on deposit in bank accounts held jointly with S2 with rights of survivorship in the amount of $2 million. S1 made no taxable gifts during life. S1’s executor is not required to file an estate tax return and does not file such a return.
S2 dies on Jan. 30, 2015. S2’s taxable estate is $8 million, and S2 made no taxable gifts during life. S2’s executor files a Form 706 on behalf of S2’s estate on Oct. 30, 2015, claiming an applicable exclusion amount of $5.43 million. S2’s executor includes payment of $1.028 million (($8,000,000 – $5,430,000) x 40 percent) of estate tax with the Form 706.
Pursuant to this revenue procedure, S1’s executor has until Jan. 2, 2018 to file a complete and properly prepared Form 706 on behalf of S1’s estate, electing a deceased spousal unused exclusion (DSUE) amount of $5.43 million. In addition, the executor of S2’s estate must file Form 843, Claim for Refund and Request for Abatement, claiming a refund of the $1.028 million estate tax paid with the original filing, before Oct. 30, 2018.
Clarity for Surviving Spouses
In numerous private letter rulings since 2001, the IRS has provided relief when an estate made an unnecessary QTIP election to qualify property for the marital deduction in the estate of the first spouse to die. To the surviving spouse’s benefit, the property for which the election was revoked did not need to be included in the surviving spouse’s gross estate.
With the increased unified credit, a portability election allowing an increased DSUE to pass to the surviving spouse, and the possibility of a stepped-up income tax basis on the surviving spouse’s death, unnecessary QTIP elections now provide possible benefit. Some advisers have been reluctant to make QTIP elections in conjunction with portability elections because they were concerned the IRS would reverse the QTIP election planning using Rev. Proc. 2001-38. However, in Rev. Proc. 2016-49, the IRS reassured advisers that it will not nullify a taxpayer’s planning if the portability election and QTIP elections are made. The new procedure requires an affirmative election by the taxpayer to nullify a QTIP election.
The Estate of Frank Sower
In 2012, Frank Sower died. On his estate tax return, the executor made a portability election. The IRS issued a closing letter regarding Sower’s estate tax return. After Minnie Sower’s death in 2013, the executor used her unified credit, increased by Frank’s DSUE, to avoid tax on her estate tax return. The IRS audited Minnie’s estate tax return and re-examined Frank’s estate tax return, the one on which the DSUE election was made. The IRS found undisclosed gifts made by Frank that did not lead to tax on his return, but did reduce the DSUE passing to Minnie, resulting in estate tax on her return. The executor of Minnie’s estate filed suit contesting the audit of Frank’s estate tax return. Holding for the IRS, the Tax Court cited Section 2010(c)(5), which provides that the usual three-year statute of limitations on the first return is waived if the DSUE election is made. This decision illustrates one downside of making the DSUE election: the return on which the DSUE election is made remains subject to audit until the DSUE is used, possibly years later.
Portability Election Is Not a Property Right
In the case of the estate of Anne S. Vose v. Lee, the Oklahoma Supreme Court affirmed the lower court’s decision forcing the executor to file an estate tax return making the portability election, even though the surviving husband had signed a prenuptial agreement waiving all claims and rights in the estate. The court noted that a valid prenuptial waiver requires full knowledge of the rights intended to be waived. The portability election provisions were enacted in 2010 after the prenuptial agreement was signed in 2006. Furthermore, the portability election is not a property right normally encompassed by a prenuptial agreement.
The court further held that, even though the surviving husband was not a beneficiary of the estate, the personal representative had a fiduciary obligation to the husband as a party who had an interest in the estate. The court reasoned that the estate was not harmed because the surviving husband agreed to pay any costs to file the return and make the election.
This is the first case addressing what could be a common situation in the future when the first to die’s survivors do not want to bear the cost, inconvenience, or future audit risk of making a portability election that would only benefit a surviving step-parent.
The portability exclusion has significantly changed the estate tax and income tax strategies available to married couples planning their estates. It is especially important to review estate plans created prior to 2010 that require the funding of a bypass trust. These trusts will not benefit from a stepped-up income tax basis when the surviving spouse dies and may preclude the portable exclusion election. As these recent developments demonstrate, taxpayers, the courts, and the IRS are identifying the lines in this new planning area.