Under the federal estate and gift tax rules, a transferor incurs no tax liability unless and until cumulative gift-giving (lifetime and deathtime combined) exceeds the exemption amount. The exemption amount is $5.0 million, but adjusted for inflation. The 2014 adjusted amount is $5,340,000. This means that a couple can leave up to $10,680,000 tax free to the next generation.
Before “portability” was added to the Internal Revenue Code, the only way for a couple to be sure that they could take advantage of this huge amount of tax-free wealth transfer was to engage in sophisticated tax planning. For example, assume that the spouses each have estates of $5.0 million. If the first to die spouse were to have a simple will leaving everything to the surviving spouse, there would be no tax on the first spouse’s estate. But if the second spouse had no occasion to consume any of the combined capital of $10.0 million, or perhaps very little of it, then the estate of the second spouse would owe some tax. The way to avoid this, with advance estate planning, is to place the $5.0 million owned by the first spouse in something called a bypass trust (or sometimes called a credit shelter trust, or a family trust). The surviving spouse could enjoy the income from the trust, and a trustee could even be given power to invade corpus for the benefit of the surviving spouse. But if the bypass trust was correctly drafted, the surviving spouse would not have a sufficient interest in the trust to include the trust assets in the estate at death. The bypass trust would then pass to the next generation tax free, as would the $5.0 million estate of the surviving spouse, which is below the exemption amount.
The problem is that not everyone does the necessary estate planning before the death of the first spouse. Or, the problem could be that the couple had no idea how large the estate of the second spouse might be. A surviving spouse that inherits only a couple of million from the first to die spouse, may look like a relatively non-wealthy person with assets of $4 million or less. But things can change. A lottery jackpot, an unexpected inheritance, stock options that suddenly become very valuable – these are all events that can push the surviving spouse above the exemption amount.
“Portability” is the answer here. Under “portability,” the surviving spouse can elect to have the deceased spouse’s unused exemption (tax planners call this the DSUE) added to the surviving spouse’s exemption amount. But to do this, you have to file a federal estate tax return at the death of the first spouse, even though there is no taxable estate. The return is the only way to make the “portability” election. The problem is that an estate tax return is due 9 months after death.
The problem is obvious when you consider same-sex spouses, whose marriages were not recognized by the IRS until the Windsor decision on June 26, 2013. For deaths of same-sex spouses that occurred in 2010, 2011, and most of 2012, the nine month period had run. The only way to get an extension would be to request one under the rules set forth in Treasury Reg. § 301.9100-3. But that can be a complicated and costly process.
Now the IRS has provided a more sensible solution to this problem – and not just for same-sex spouses. In Rev. Proc. 2014-18, the IRS provides a process for claiming portability for any spouse who died between December 31, 2010 and December 31, 2013. (Portability was first available on January 1, 2011.) So long as there was a surviving spouse and provided that the estate of the deceased spouse had not been required to file an estate tax return (i.e., because it was below the exemption amount), an estate tax return, electing portability, will be deemed timely filed if it is filed by December 31, 2014.
Recommendation: If you have a situation involving a same-sex married couple, legally married in the jurisdiction of celebration, and one of the spouses died during the relevant time period (2011-2013), then consider whether it makes sense to file an otherwise unnecessary estate tax return solely in order to claim the potential benefit of portability.
How do you decide when to file a return and elect portability? That is not a simple question to answer. The CalCPA web page contains a 2012 post that provides some thoughts about this, including the following advice about potential liability.
What This Means to CPAs and the Potential Liability
CPAs should consider filing federal estate tax returns for all decedents who have a surviving spouse. No one knows what the financial situation of the surviving spouse will be when they die. If the election is not made, and the surviving spouse has a taxable estate that could have been avoided if the election had been made, there are potential grounds for a lawsuit against the executor who did not make the election and the advisers, be they CPAs or attorneys, involved.
If the executor does not want to file a Form 706 to make the election, the CPA would be well-advised to have documentation in the file indicating that the election was discussed and the executor chose not to make the election.
To view the entire post go to http://www.calcpa.org/content/26653.aspx