Relief for Missed Portability Elections
a. Portability was supposed to simplify the estate tax system. Prior to portability, if one spouse died, to secure that deceased spouse’s exemption required affirmative planning in most cases. The deceased spouse’s will or revocable trust generally would have had to include a credit shelter trust to benefit the surviving spouse but avoid inclusion in the survivor’s estate thereby securing the exemption. Title to assets had to have also been structured to facilitate funding of that trust. If the required planning was not implemented, which generally required incurring legal fees and bearing the cost and complexity of the planning, the exemption of the first spouse would have been wasted. The law was modified in 2010 to provide a simpler low cost alternative so that taxpayers that did not hire more sophisticated estate planning counsel, could also benefit from the exemption of the first spouse to die. Section 303(a) of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Pub. L. No. 111-312, 124 Stat. 3296, 3302 (2010), amended § 2010(c) of the IRC Sec. 101(a) of the American Taxpayer Relief Act of 2012 (ATRA), Pub. L. No. 112-240, 126 Stat. 2313 (2013), made portability permanent.
b. Portability was intended to facilitate the surviving spouse being able to secure the deceased spouse’s unused exemption (“DSUE”) by merely making a portability election. That DSUE could then be applied to lifetime and then testamentary transfers of the surviving spouse.
c. Unfortunately, simplicity was not really achieved by the portability concept because the mechanism to secure it, namely filing a federal estate tax return, is not understood by many taxpayers and the cost of compliance is viewed as an impediment to filing by many, especially if the benefits of porting the exemption are not assured. Decedent’s whose estates exceeded the exemption amount had to file estate tax returns and thus were less likely to miss the filing requirement, but regardless, were not covered by the recent Revenue Procedure. As a result, many taxpayers particularly those who would not otherwise have been required to file an estate tax return, missed filing the requisite estate tax return and sought relief from the IRS to rectify the situation. The due date for electing portability for those estates not required by IRC Sec 6018(a) to file an estate tax return is prescribed by Regulation, and not by statute. Treas. Reg. Sec. 20.2010-2(a). Therefore, the executor of such an estate could have sought an extension of time to elect portability under IRC Sec. 2010(c)(5)(A). Treas. Reg. Sec. 301.9100-3.
d. Portability terminology is key to understanding the provision. The applicable exclusion amount (“AEA”) is the sum of the basic exclusion amount (“BEA”) and, for the case of a surviving spouse, the DSUE amount. IRC Sec. 2010(c)(2). The basic exclusion amount is the $5 million inflation exemption amount. IRC Sec. 2010(c)(3). This Regulation provides the standards by which the IRS can determine whether to grant an extension of time to make an election whose due date is prescribed by a regulation or other administrative guidance and not by statute.
e. Requirements for Leniency.
i. The executor satisfies all requirements of Section 4.01 of the Revenue Procedure.
ii. Action must be taken by the executor. This is either the executor appointed under the will. If there was no person appointed as executor, then by a non-appointed executor. Treas. Reg. Sec. 20.2010-2(a)(6)). The action required is filing a complete and properly prepared estate tax return, Form 706. The return must be filed on or before the later of: (1) January 2, 2018, or (2) the second annual anniversary date of the decedent’s date of death. The “complete and properly prepared” criteria are set forth in the regulations. Reg. Sec. 20.2010-2(a)(7). The tax return must state at the top of the form: “FILED PURSUANT TO REV. PROC. 2017-34 TO ELECT PORTABILITY UNDER § 2010(c)(5)(A).”
iii. The decedent had to have been survived by a spouse.
iv. The decedent died after December 31, 2010.
v. The decedent was a citizen or resident of the United States on the date of his or her death.
vi. The executor was not required to file an estate tax return for the estate based on the value of the gross estate and adjusted taxable gifts. IRC Sec 6018(a). This obviously does not include the requirement to have filed to secure the DSUE. If, subsequent to the grant of relief under the Revenue Procedure, it is determined that, based on the value of the gross estate and taking into account any taxable gifts, the executor was required to have filed an estate tax return under § 6018(a), the leniency of an extension will be void.
vii. The executor did not in fact file a federal estate tax return within the time required by for filing an estate tax return. Treas. Reg. Sec. 20.2010-2(a)(1). If a return was filed, but the executor affirmatively opted out of the portability election, the leniency of the Revenue Procedures appears to be available. Treas. Reg. Sec. 20.2010-2(a)(3)(i). This result, while favorable to taxpayers is not as clear as to why it was included as the executor in such a situation obviously understood the filing requirement. Perhaps this leniency is being offered because many executors filing did not understand the implications of portability.
f. If the estate is granted relief under this Revenue Procedure the estate tax return is considered to have been timely filed for purposes of electing portability, and the DSUE amount of the decedent will be available to the surviving spouse (or the estate of the surviving spouse) for application to the surviving spouse’s transfers made on or after the decedent’s date of death. The application of the DSUE will follow the sequences provided for in the Regulations. Reg. Sec. 20.2010-3 and 25.2505-2. of the Gift Tax Regulations.
g. Relief is not without exception. If the increase in the surviving spouse’s applicable exclusion amount attributable to the addition of the decedent’s DSUE amount as of the decedent’s date of death results in an overpayment of gift or estate tax by the surviving spouse (or his or her estate), no claim for credit or refund of that tax paid may be made if the period of limitations under Code Sec. 6511(a) for filing a claim for credit or refund of an overpayment of tax has expired. Thus, the extension of time to elect portability granted under the Revenue Procedure does not extend the period during which the surviving spouse or the surviving spouse’s estate may make a claim for credit or refund.
h. Revenue Procedure 2017-34 includes three examples which illustrate application of the new rules. These are reproduced below.
i. Revenue Procedure Example 1. Predeceasing Spouse (S1) dies on January 1, 2014, 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 $2,000,000. S1 made no taxable gifts during life. S1′s executor is not required to file an estate tax return under § 6018(a), and does not file such a return. S2 dies on January 30, 2014. S2′s taxable estate is $8,000,000 and S2 made no taxable gifts during life. S2′s executor files a Form 706 on behalf of S2′s estate on October 30, 2014, claiming an applicable exclusion amount of $5,340,000. S2′s executor includes payment of the estate tax with the Form 706. Pursuant to this revenue procedure, S1′s executor files a complete and properly prepared Form 706 on behalf of S1′s estate on December 1, 2017, reporting a DSUE amount of $5,340,000. The executor includes at the top of the Form 706 the statement required by section 4.01(2) of this revenue procedure. The filing of the return satisfies the requirements for a grant of relief under this revenue procedure and S1′s estate is deemed to have made a valid portability election. The Service accepts S1′s return with no changes. To recover the estate tax paid, S2′s executor must file a claim for credit or refund of tax by October 30, 2017 (the end of the period of limitations prescribed in § 6511(a)), even though a Form 706 to elect portability has not been filed on behalf of S1′s estate by that date. Such a claim filed on Form 843, Claim for Refund and Request for Abatement, in anticipation of the filing of the Form 706 by S1′s executor will be considered a protective claim for credit or refund of tax. Accordingly, as long as the Form 843 is filed on or before October 30, 2017, the Service can consider and process that claim for credit or refund of tax once S1′s estate is deemed to have made a valid portability election and S2′s estate notifies the Service that the claim for credit or refund is ready for consideration.
j. Revenue Procedure Example 2. The facts relating to S1 and S1′s estate are the same as in Example 1. S2 makes a gift to Child of $6,000,000 on December 1, 2014. S2 has made no prior taxable gifts. On April 15, 2015, S2 files a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, claiming an applicable exclusion amount of $5,340,000. S2 tenders payment of the gift tax with the Form 709. To recover the gift tax paid, S2 must file a claim for credit or refund of tax (protective or otherwise) within the time prescribed in § 6511(a) for filing a claim for credit or refund.
k. Revenue Procedure Example 3. The facts are the same as in Example 2 except that S2′s Form 709 claims an applicable exclusion amount of $10,680,000 including a DSUE amount of $5,340,000 from S1′s estate. As a result, the Form 709 reports no tax due and S2 tenders no gift tax. Although the portability election, once made, makes S1′s DSUE amount available to S2 retroactively to S1′s date of death, that DSUE amount is not available until the election is made. Because S2 files the Form 709 before S1′s estate makes the portability election, S2′s claimed application of the DSUE amount will be denied and gift tax on the transfer will be assessed. To recover that gift tax once the portability election has been made by S1′s estate, S2 must file a claim for credit or refund of tax (protective or otherwise) within the time prescribed in § 6511(a) for filing a claim for credit or refund.
2. Reference. Revenue Procedure 2017-34, Internal Revenue Bulletin 2017-26, dated June 26, 2017.
3. Planning Considerations.
a. Any client whose spouse died after 2010 that did not file an estate tax return, and the estate of the deceased spouse was less than the estate tax exemption, should carefully consider filing an estate tax return under the leniency provided by a recent IRS Revenue Procedure, to secure portability of that deceased spouse’s used exemption (“DSUE”). Practitioners should consider communicating this important message to all clients so that those affected may take action. The cost benefit of this for many clients should be relatively simple. The cost of having an estate tax returned prepared merely to secure the DSUE should be rather inexpensive. There are three categories of clients affected. First are clients who need the DSUE. For example, husband died in 2011 with an estate of $2M and no estate tax return was file. Wife died in 2017 with an estate of $7M. Without the DSUE a tax would be due. If the DSUE secured by following the steps outlines in the Revenue Procedure estate tax will be avoided. For these clients the benefits of filing are clear. The second class of clients might be those who may need the DSUE in the future. An example would be the couple and estate above, but the wife is still alive so the results are not yet assured (e.g., she might engage in tax planning the exemption will rise if the estate tax is not repealed, the estate tax might be repealed, etc.). For these clients, given the modest cost of compliance filing should be made. The third category of clients are those that are unlikely under current law and circumstances to have use for a DSUE. For example, husband died in 2011 with an estate of $2M. Wife inherited that $2M and has $2M of assets of her own for an aggregate estate of $4M. Under current law there is no benefit to securing the DSUE. But what if wife remarries someone wealthy, might there be a benefit to having secured the DSUE from her first husband to cover gifts of her $4M estate? What if, regardless of what happens to the estate tax under a Trump Administration, the estate tax is reinvigorated under a future democratic administration such that a tax might be due? While the likelihood of these scenarios might be viewed as modest, the cost of having an estate tax return filed to secure the DSUE may be only a few thousand dollars. Is that modest cost worth the potential benefit? At a $4M estate level the cost is insignificant, although the client might not view it as such. Even if the exemption is not needed, the downside is generally limited to the cost of filing (and the statute of limitations on an audit remaining open which needs to be evaluated but which in most instances involved may not be a material concern). While many clients that could benefit might dismiss securing the DSUE as not worthwhile, just as they may have done if they made a conscious decision not to file following the death of their spouse. Now in particular, with the specter of estate tax repeal a possibility is securing a DSUE worth the modest bother and cost? Unfortunately, for most client that will be unknown without the benefit of hindsight. However, even if the estate tax system is repealed but reinstated by a future administration, having secured the DSUE may prove worthwhile. For most, the cost of filing is not a heavy price to pay “just in case.”