Journal of Financial Planning; April 2014
Michael E. Kitces, CFP®, CLU®, ChFC®, RHU, REBC, is a partner and the director of research for Pinnacle Advisory Group. He is the publisher of the e-newsletter The Kitces Report and the blog Nerd’s Eye View. He also serves as practitioner editor of the Journal of Financial Planning. Follow him on Twitter at @MichaelKitces.
The potential for portability of a deceased spouse’s unused exemption amount (DSUEA) to a surviving spouse was a significant change that emerged from the fiscal cliff legislation in 2010. However, early adoption of portability was limited, both because of a lack of awareness of the rule by many of those who needed it, and the fact that the portability rules were originally temporary. With temporary portability, its applicability was very limited; it would only apply if the first spouse died on or after January 1, 2011, (when the rules took effect), and the second spouse died by December 31, 2012, (before the rules lapsed). With the Taxpayer Relief Act of 2012, portability was made permanent, but by that time it was already too late for many and the filing deadline had already passed.
To provide relief for this unfortunate situation, the IRS issued Revenue Procedure 2014-18 on January 27, creating a new opportunity for executors to go back for any decedent who died in 2011, 2012, or 2013, and have an extension to file an estate tax return to claim portability of a decedent’s estate tax exemption for the surviving spouse. However, the relief provision reopening portability for anyone who died in the past three years is itself temporary; the Form 706 estate tax return must be filed by the end of 2014, or the window will once again be closed for good (and portability will only be available within the normal nine-month-plus-extensions filing window).
In situations where the surviving spouse has also since died, the potential for retroactive portability could actually result in an immediate and significant estate tax refund. For same-sex spouses who couldn’t file for portability in 2011, 2012, or most of 2013 because the marriage wasn’t federally recognized, the new relief provision offers the opportunity to go back and claim portability for a same-sex surviving spouse.
Portability Relief under Rev. Proc. 2014-18
In order for the portability relief to apply, Rev. Proc. 2014-18 stipulates the following requirements:
- The decedent must have had a surviving spouse at the time of death; died after December 31, 2010, and on or before December 31, 2013; and been a U.S. citizen or resident at the time of death.
- There must not have otherwise been a requirement to file an estate tax return. For example, per IRC Section 6018, if the decedent’s estate was under the estate tax exemption amount, so there was no requirement to file, and it is later determined that the gross estate was large enough that an estate tax return should have been filed in the first place, this part of the requirement is not satisfied.
- An estate tax return was not already filed. If the decedent’s estate already filed a return and specifically opted out of portability, that election can’t be undone to claim portability now.
If these requirements are met, the decedent’s estate can retroactively claim portability by simply filing a proper Form 706 by the end of the year. Under the normal rules for portability, no further election is necessary to claim portability, and the mere act of filing the return itself, and not specifically electing out of portability, is sufficient to claim a carryover of the DSUEA to the surviving spouse. However, with this relief provision, if the Form 706 federal estate tax return is specifically being filed retroactively to claim portability, the IRS indicates that the following should be written across the top of the return: “Filed Pursuant to Rev. Proc. 2014-18 to elect portability under IRC section 2010(c)(5)(A).” If the form is properly and timely filed, the IRS will provide an estate tax closing letter to acknowledge receipt of the Form 706.
Those who don’t meet the requirements to retroactively claim portability (or who fail to file by the new December 31, 2014, deadline) are still allowed to apply for a private letter ruling (PLR) with the IRS to request relief (albeit with a user fee of up to $10,000). However, the IRS also notes that it will not respond to letter rulings until 2015 for estates that would be eligible to follow these rules. For those who had already submitted a PLR request for relief, the IRS says the PLR can be withdrawn and the user fee will be refunded, if the decedent’s estate wishes to simply rely on these new rules instead.
Estate Planning Implications
With Rev. Proc. 2014-18, any widow(er) who had a spouse die in the 2011 to 2013 timeframe should at least consider filing an estate tax return to claim portability.
Arguably, the only reason not to file for portability under the new relief provisions is simply if the surviving spouse is so unconcerned about potential federal estate tax exposure in the future that he or she doesn’t want to go through the cost of filing the return. However, the cost for filing should be relatively low, given that the IRS allows for “simplified” reporting under Treasury Regulation 20.2010-2T(a)(7)(ii), where no detailed appraisals for illiquid assets—such as the primary residence—are necessary, and estimated values for illiquid assets rounded to the nearest $250,000 are sufficient.
It’s also notable that this portability relief is applicable for same-sex married couples who were legally married but could not file an estate tax return to claim portability to a surviving spouse because the same-sex marriage was not federally recognized until the IRS issued Revenue Ruling 2013-17 last year after the Supreme Court’s decision in United States v. Windsor that struck down Section 3 of DOMA. Nonetheless, given that the IRS does now recognize the marriage—assuming it really was a legally recognized marriage under state law at the time—the opportunity for a surviving same-sex spouse to file for portability is now available, along with the potential to file a refund claim if the first spouse had owed estate taxes at death due to the lack of a spousal deduction, and if the second same-sex spouse also already passed away and owed estate taxes, but now wishes to claim a refund given the availability of portability.
In some situations, a spouse may have died within the time window and the second spouse may have died thereafter. In this situation, if the second spouse had an estate tax liability, there will be a benefit to going back and claiming portability for the first estate so that the DSUEA can be used in the second estate (the IRS explicitly allows this in its new guidance).
For example, if Harold died in 2011 and left all his assets to Maude, and Maude died in 2013 with an $8 million estate (when the estate tax exemption was then only $5.25 million), clearly it will be desirable to file an estate tax return for Harold to claim portability. As it stands, Maude will be subject to a 40 percent federal estate tax rate on the last $2.75 million of her estate for a liability of approximately $1.1 million. But, if she were able to carry over Harold’s $5 million DSUEA from 2011, her estate tax exposure would be reduced to $0!
Ultimately, in many situations, assets and net worth are low enough that there is no realistic possibility that the surviving spouse’s net worth will grow above the current $5.34 million estate tax exemption (which itself is indexed for inflation and rises over time), and as a result the surviving spouse may feel that net worth is low enough that filing for portability is just not worthwhile. On the other hand, in a world where anyone can win the lottery, and younger clients who are still working can potentially accumulate significant wealth over time, advisers who discuss retroactive portability with their clients and decide not to proceed would be wise to document the discussion and conclusion in their client notes.
At a minimum, every surviving spouse who became a widow(er) in the 2011 to 2013 time frame should at least carefully consider whether it’s worthwhile to file a simplified Form 706 estate tax return to claim portability, while the opportunity exists until the end of 2014, as Rev. Proc. 2014-18 has provided significant relief, but only temporarily.