IRS Issues “Portability” Guidance

The Alert this month examines “portability” and the steps necessary to take advantage of it under newly-released regulations.

For many years estate planning attorneys have had to draft complicated provisions into the estate plans of married couples in order to make maximum use of the applicable exclusion amount (the “AEA”). The AEA is the amount that can pass free from estate tax at the death of an individual. Technically, even without “portability,” a married couple can pass twice the AEA to their children or other beneficiaries. But if each spouse leaves all his or her assets outright to the surviving spouse, the AEA of the deceased spouse is lost. For this reason, the concept of portability has been an issue for estate planning attorneys and Congress for many years.

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 provides for portability of the AEA between spouses when the first spouse dies after 2010, but before 2012. Unless renewed by Congress, the act is scheduled to expire in 2012. The AEA consists of the basic exclusion amount (the “BEA”) and deceased spouse unused exclusion amount (the “DSUEA”). In order for the surviving spouse to take advantage of portability, the deceased spouse’s estate must timely file a Form 706 estate tax return, compute the DSUEA, and elect portability.

In Notice 2011-42, the IRS said that if the first spouse’s estate timely files a complete and properly-prepared estate tax return, it will be deemed to have elected portability. In addition, until the IRS revises the estate tax return to expressly contain the DSUEA computation, the estate tax return will be deemed to include the DSUEA computation. In Notice 2012-21, the IRS granted a 6-month extension of time to estates of decedents dying in the first half of 2011 to file the estate tax return in order to elect portability when the gross estate is under $5 million. The IRS has now issued temporary regulations governing portability, which are effective June 15, 2012.

The temporary regulations require the estate to elect portability on a timely-filed estate tax return. The last timely-filed return (including extensions) will control. However, once the estate tax return due date (including extensions actually granted) has passed, the election is irrevocable.

Notice 2011-82 says that the estate must file a complete and properly-prepared Form 706. The new temporary regulations relax this requirement. The estate must estimate the value of the gross estate. In most cases, the executor need not report the value of property that qualifies for the marital or charitable deduction. However, in certain cases, the estate will nevertheless be required to report the value of property qualifying for the marital or charitable deduction. The estate will have to report the value of these assets 1) if the value relates to, affects, or is needed to determine the value of property passing to another recipient, 2) if the value is needed to determine eligibility for alternate valuation, special use valuation or installment payment of the estate tax, 3) if less than the entire value of an interest in property includible in the estate is marital or charitable deduction property, or 4) if a partial disclaimer or partial QTIP election is made with respect to a bequest, devise, or transfer part of which is marital or charitable deduction property. Otherwise, the Form 706 will show ranges of dollar values, and the estate will have to identify the range within which it estimates the gross estate falls. Of course, the executor will have to determine the value of all the assets in the estate in order to properly administer the estate and to determine the tax basis of the assets. He or she may also have to file a state estate tax return. If an estate does not want to elect portability, it will have to affirmatively state that on the return (or simply not file a return if a return is not otherwise required).

The executor, not the spouse, is the one who is authorized to file the return to elect portability. One commentator suggested that the surviving spouse should be able to do so. However, the IRS rejected this suggestion. This creates several questions. Must the executor file a return and elect portability if the surviving spouse so requests? Can the surviving spouse be appointed as a special executor or administrator for the limited purpose of preparing and filing the return to elect portability if the executor does not want to do so? Who pays the cost of preparing the return, the estate or the surviving spouse?

The temporary regulations clarify that the DSUEA is the lesser of the basic exclusion amount or the excess of the basic exclusion amount of the surviving spouse’s last deceased spouse over the amount with respect to which the tentative tax was determined with respect to such deceased spouse’s estate. However, where the deceased spouse was preceded in death by one spouse and survived by another spouse, the deceased spouse’s DSUEA is computed using the applicable exclusion amount rather than the basic exclusion amount. Gifts on which gift tax was paid are excluded from adjusted taxable gifts for purposes of computing the DSUEA. The IRS has requested comments from practitioners on whether the DSUEA is determined before or after the application of other credits – the credit for the tax on prior transfers, the foreign death tax credit and the estate tax on remainder interests.

The temporary regulations clarify that if the surviving spouse remarries, the DSUEA will still be available to the surviving spouse as long as his or her new spouse is living. Therefore, a surviving spouse who remarries may want to use his or her DSUEA, to protect against losing it upon the death of his or her new spouse. However, if the surviving spouse remarries and divorces, the death of the new spouse will not destroy the DSUEA from the first deceased spouse, since the second spouse, not being married to the surviving spouse at death, is not the last deceased spouse.

The estate of a decedent who was neither a United States citizen nor a United States resident may not elect portability, except to the extent allowed under a treaty. In general, if property of a decedent passes to a qualified domestic trust (QDOT) for the benefit of a noncitizen spouse, the decedent’s estate will compute the DSUEA on a preliminary basis, and will recompute it upon the surviving spouse’s death. Therefore, the DSUEA will generally not be available to the surviving spouse during his or her lifetime. Again, the IRS has requested further comments from practitioners on this subject.

If a surviving spouse who has a DSUEA makes a taxable gift, the DSUEA is applied first, before using the surviving spouse’s own basic exclusion amount. This facilitates the use of the DSUEA by a surviving spouse who remarries, who risks losing it if the new spouse predeceases him or her.

Planning for reduction of estate taxes can be very complicated, with many issues to consider. Our office has extensive experience with this type of specialized planning. As a member of the American Academy of Estate Planning Attorneys, a nationwide membership organization for estate planning attorneys, our firm is kept up to date with information regarding income, gift, estate and generation-skipping transfer taxes. You can get more information about a complimentary review of your clients’ existing estate plans and our planning and administration services by calling or by visiting our website.