Virginia State Bar

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Trusts and Estates

A Section of the Virginia State Bar.

Fall 2014 Newsletter

Newsletter - Trusts and Estates

Volume 22, No. 11

Making the Portability Election
By James A. Gillis

Estate planning attorneys have been working with portability for almost four years now. Since January 1, 2011, the executor of an estate with a surviving spouse has had the ability to make a portability election to claim the deceased spousal unused exclusion (DSUE) amount.1 Once ported to the surviving spouse, the surviving spouse can use the DSUE amount to shield future asset transfers from estate and gift taxes. In order to make the portability election, a full and timely estate tax return which calculates the DSUE amount must be filed.2 Depending on the circumstance, the DSUE amount can be very valuable. A portability election made in 2014 can save up to $2,136,000 in gift and estate taxes.

Although perhaps in theory designed to simplify the estate planning process and bring an element of fairness to decedents who failed to employ traditional tax planning, portability in practice adds another layer to the estate administration process. Whenever there is a surviving spouse, the estate attorney needs to consider and advise the executor about the portability election to some degree. This article discusses the mechanics of making the portability election, the content of the attorney’s advice pertaining to portability, and using the ported DSUE amount.

Portability should always be considered when available because it can be so valuable. For example, if a married couple owned all of their assets jointly and one spouse died in 2014, a DSUE amount of $5,340,000 could be ported to the surviving spouse. If the surviving spouse died later that year with $10,680,000 of assets, no tax would be due. If no portability election had been made, the estate tax bill would be $2,136,000.

That said, the burden of making the portability election is significant. If an executor would like to make the election, the executor needs to be prepared for the diligence and legal fees required to prepare a full-blown estate tax return. An effective portability election requires that a “complete and properly-prepared estate tax return” be filed which calculates the DSUE amount.3 The return must be filed on time – within nine months of the date of death, or within fifteen months if the executor requests an automatic extension.4

When an estate tax return is being filed solely to elect portability, a limited shortcut is available. The executor can estimate the date of death value of property that is completely shielded by the marital and charitable deductions.5 The return still must report a description of the property and all other information necessary to establish the estate’s right to the marital and charitable deductions, along with an estimate of the total value of the estate.6 This method could save money if, for example, the decedent owned a closelyheld business that passes to the surviving spouse, and the surviving spouse is not planning to sell the interest. In that case, the cost of a business valuation could be avoided; however, this shortcut could turn out to be a landmine later if the surviving spouse decides to sell or gift the interest because the basis for income tax purposes would not be readily available. The attorney should carefully consider whether the potential savings are worth the risk before giving advice in this area.

A portability election can only be made on a timely filed estate tax return, but all is not lost if the filing deadline has passed. The executor could still make a portability election as long as there was no statutory requirement that an estate tax return be filed. A return is not required by statute if the value of the gross estate plus adjusted taxable gifts is less than the applicable exclusion amount in the year of death ($5,340,000 in 2014, indexed for inflation). Because the deadline for making a portability election is set by regulation, a private letter ruling (PLR) request can be made asking for an extension of time under Section 301.9100-3 of the Procedure and Administration Regulations to make the election. The PLR request must establish that the executor acted reasonably and in good faith, and that the grant of relief will not prejudice the interests of the government. 7

An additional automatic extension of time is available for estates with decedents who died in 2011, 2012, and 2013. In 2013, United States v. Windsor struck down Section 3 of the Defense of Marriage Act.8 As a result, the IRS was required to recognize same-sex couples for all tax purposes. The IRS issued several revenue procedures in the wake of the Windsor decision that automatically allowed surviving spouses of same-sex couples to file late estate tax returns for the sole purpose of electing portability. Because the law was new and changing (prior to Windsor, there were disagreements as to the requirements for making a valid portability election), the IRS extended late filing for the purpose of electing portability to all estates.9 If the decedent died in 2011, 2012, or 2013 with a surviving spouse, but without an estate tax return filing requirement, the executor can file an estate tax return electing portability by December 31, 2014. In order to do so, the return must state that it is “FILED PURSUANT TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER §2010(c)(5)(A).”10

Before portability was law, determining whether there was an estate tax return filing requirement was an objective exercise. The total value of the estate was either above or below the filing threshold. Some of the valuations may have been subjective, but the conclusion of whether or not to file was based on an objective measure. Not so with portability. If no return is required by statute, a subjective determination of whether the return should be filed must be made by the client.

The attorney has a key role in helping the client through the decision-making process. Because the DSUE amount can be so valuable, it is critical that certain pieces of information be conveyed to the client in a meaningful and useful format. Inputs are needed, so whenever there is a surviving spouse, the attorney needs to gather information about all of the assets and taxable gifts of the decedent and of the surviving spouse. Requests for that information should be added to the standard checklist that is given to the client at the start of the representation. The client’s failure to act (i.e., not filing the return) constitutes electing out of portability and that election becomes irrevocable when the filing due date passes. With limited exceptions, the election cannot be revoked, so if the executor is not going to file the return, an affirmative informed decision should be made either way.

The client’s options with respect to the portability election, as well as his or her decision regarding the election, should be confirmed in writing. Creating a written record signals to the client that the decision should be taken seriously and also protects the attorney from potential malpractice claims. It is not enough to inform the client in a conclusory manner that the client can file an estate tax return to claim the DSUE amount; technical details are by and large not helpful to the client’s decision-making process in this context. The attorney has an ethical duty to present the options in clear economic terms to help the client make an informed decision.11

If the attorney is representing the surviving spouse, a full picture of the assets should be obtained and presented. There are two calculations that should be emphasized to the client. First is the estimated estate tax (if the surviving spouse has over $5,340,000 of assets) or the remaining exemption (if the surviving spouse has less than $5,340,000 of assets) if nothing is done, based on the current asset values and the current state of the law. Second is that same calculation (tax or remaining exemption) if a portability election is made. The presentation style should be tailored to the client’s level of sophistication, but at least showing the basic arithmetic can act as a check that helps ferret out errors. One strategy is to present the two key calculations in the body of a simple one page letter, and to enclose one or more spreadsheets detailing the estate’s assets, the surviving spouse’s assets, and the tax calculations.

The letter should make it clear that the estimated tax or remaining exemption is calculated as of the present time and that the client should take this information to the client’s financial advisor for projections regarding future values. This is especially true if the surviving spouse is younger with significant earning potential. Even if no tax would be due now, there could be significant growth of the assets over time such that the survivor’s estate could reasonably be expected to owe tax.

The final piece of information is the estimated cost to the client of making the portability election. Preparing an estate tax return is neither easy nor inexpensive. The client needs to be able to weigh the costs to be able to make an informed decision. If the situation is borderline, it is appropriate to emphasize the potential tax savings because of its potential significance. Most wealthy clients will agree that it is worth spending a few thousand dollars now to potentially save hundreds of thousands or millions of dollars of tax later. Some will not. That is why there should be a space for the client to sign the letter indicating whether or not the client wants to proceed with making the election. Of course there should be a warning near to where the client is signing confirming that a decision not to proceed will become irrevocable once the filing deadline has passed. It may be tempting to advise the hesitant client to file an automatic extension request; however, delaying decision-making when all of the information is available is rarely a good idea.

The only person with the power to make the portability election is the executor, which for estate tax purposes and for purposes of making the portability election is the court-appointed personal representative. 12 If one has not been appointed, any person in actual or constructive possession of the decedent’s property is considered the executor.13 In many cases, the surviving spouse is the executor. If not, the attorney should be thinking about the potential conflicts between the executor’s fiduciary duties and the executor’s interest in the estate as a beneficiary, and address any conflicts from the start of the representation.

For example, the surviving spouse could have signed a marital agreement waiving all inheritance rights, there could be two sets of children and different estate plans, or a child of the decedent but not of the surviving spouse could be serving as executor. If the surviving spouse would like the executor to make the portability election, there is a conflict of interest between the executor’s fiduciary duties and the executor’s interest in the estate as a beneficiary because preparing the estate tax return is an administrative expense paid from the residue. The contours of the fiduciary duties under these circumstances may be fuzzy. A Virginia executor is charged by statute “with the responsibility of filing any income, inheritance or estate tax returns required by state or federal law ….”14 Whether an estate tax return is required under the statute if the surviving spouse requests that one be filed may be a stretch, but there may be a common law fiduciary duty that makes filing a requirement under certain circumstances. It may seem fair but unadvisable to have the surviving spouse pay for the return. When portability is available, but the surviving spouse is not serving as executor, sifting through the facts of the situation, evaluating how the law applies to that situation and establishing a plan regarding the portability election so that there is a predetermined course of action is time well spent.

The surviving spouse can use the ported DSUE amount to shield future gifts and transfers at death from tax. In the gift tax context, the DSUE amount is used before the surviving spouse’s own applicable exclusion amount.15 A surviving spouse can only have one DSUE amount at a time. Remarriage does not destroy the DSUE amount of a surviving spouse, but if the remarriage ends in death, the surviving spouse loses the DSUE amount ported from the first deceased spouse to the extent it is not applied to taxable gifts. For example, if a remarried surviving spouse makes $2 million of taxable gifts, the DSUE amount is used first. If the surviving spouse’s new spouse dies, the surviving spouse keeps the $2 million prior DSUE amount because it was already applied to lifetime taxable gifts, but loses the rest of the DSUE amount.16 Of course, a new portability election can be made to claim the second deceased spouse’s DSUE amount.

At death, the DSUE amount can be used by a U.S. citizen or a resident alien. It can only be used by a non-resident alien if there is a tax treaty in place.17 One thing to keep in mind is that the IRS has the authority to examine the estate tax return whenever the DSUE amount is used.18For that reason it is a good idea to keep a complete copy of the return and all of the supporting documents in a safe and accessible place.

James A. Gillis, William L. Babcock, Jr. PC. James joined the firm in April 2012. He graduated from Villanova University in 2002 and earned his JD from the Earle Mack School of Law at Drexel University, with honors, in 2009. James is a member of the Virginia Bar Association and the Virginia State Bar (Trusts & Estates section), and is also licensed in the District of Columbia. His volunteer activities have included middle school math tutoring and the preparation of tax returns for low income individuals through the IRS Volunteer Income Tax Assistance program.

(Endnotes)

1. I.R.C. § 2010(c). The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 and the American Taxpayer Relief Act of 2012 created and made portability permanent.

2. I.R.C. § 2010(c)(5)(A).

3. Treas. Reg. § 20.2010-2T(a)(7).

4. Treas. Reg. § 20.2010-2T(a)(1).

5. Treas. Reg. § 20.2010-2T(a)(7)(ii).

6. See Treas. Reg. § 20.2010-2T(a)(7).

7. See Rev. Proc. 2014-18, 2014-7 I.R.B. 513; the private letter ruling procedural requirements are described in Rev. Proc. 2014-1, 2014-1 I.R.B. 7.

8. United States v. Windsor, 570 U.S. 12 (2013).

9. See Rev. Proc. 2014-18, 2014-7 I.R.B. 513.

10. Id. at Sec. 4.01(2).

11. VA. RULES OF PROF’L CONDUCT R. 2.1 cmt 2 (“Advice couched in narrowly legal terms may be of little value to a client, especially where practical considerations, such as cost or effects on other people, are predominant.”).

12. See Treas. Reg. § 20.2010-2T(a)(6).

13. See Treas. Reg. § 20.6018-2.

14. VA. CODE § 64.2-507.

15. See Treas. Reg. § 25.2505-2T(b).

16. See Treas. Reg. § 25.2505-2T(c).

17. Treas. Reg. § 20.2010-3T(e).

18. Treas. Reg. § 20.2010-3T(d).