| Five Requirements for the New Extension The following five requirements must be met to qualify for the automatic extension:
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The federal estate tax law currently provides unprecedented flexibility for married couples.
Case in point: If the estate of the first spouse to die doesn’t utilize the full estate tax exemption, the remainder may be used by the surviving spouse’s estate under the “portability” provision of the law. Now the IRS has granted additional time for certain estates to elect to benefit from this option. (IRS Revenue Ruling 2014-18)
Recent Estate Tax History
Culminating a decade of incremental increases under the Economic Growth and Tax Relief Reconciliation Act of 2001, the Taxpayer Relief Act of 2010 established a generous $5 million estate tax exemption for transfers to non-spouse beneficiaries, subject to indexing for inflation. (For 2014, the inflation-indexed exemption amount is $5.34 million.)
The 2010 law also included a portability provision that lets a surviving spouse’s estate use any remaining portion of the exemption. This amount is referred to as the “deceased spousal unused exemption” (DSUE) amount.
The portability provision technically expired after 2012, but was quickly reinstated and permanently extended by the American Taxpayer Relief Act of 2012 (ATRA). That law also permanently preserved the $5 million inflation-indexed exemption.
The portability provision provides a safety net for couples, including legally married same-sex couples, with joint assets exceeding the exemption amount for the estate of the first spouse to die.
Simplified example: Suppose a husband and wife each own $2 million individually and $3 million jointly with rights of survivorship, for a total of $7 million in assets. Under their wills, all assets pass first to the surviving spouse and then to the couple’s children.
Assuming that the husband dies in 2014, his $2 million in assets is covered by the unlimited marital deduction. The $5.34 million exe
mption remains unused. When the w
ife dies, her estate can use that DSUE amount, plus the exemption for the year in which she dies, to shelter the remaining $7 million of assets from tax with plenty of room to spare.
Note that the top estate tax rate is permanently set at 40 percent by ATRA. If the wife died later in 2014, $1.66 million assets would have been subject to estate tax ($7 million minus $5.34 million) without the portability provision.
This saves the family $660,000 in federal estate tax (40 percent of $1.66 million). Although other techniques such as a bypass trust may be used to avoid or reduce estate tax liability, this example demonstrates the potential impact of the portability provision.
The DSUE Election
The executor for the estate of a deceased spouse must elect portability of the DSUE amount on a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, with a computation of the DSUE amount. The election is effective only if it is made on an estate tax return filed within nine months of death, or longer with any allowable extension.
Once the estate tax is filed in a timely manner, the executor will be treated as having elected portability of the DSUE amount, unless the executor opts out based on the prevailing regulations.
If an estate is filing a return only to make a portability election, Reg. Sec. 301,9100-3 governs the rules for granting an extension of time to elect portability. Generally, relief will be granted only if the taxpayer establishes to the satisfaction of the IRS that the taxpayer has acted reasonably and in good faith. Previously, the IRS issued several letter rulings granting an extension of time to elect portability in situations in which the decedent’s estate wasn’t required to file an estate tax return.
New Automatic Extension
In the new Revenue Ruling, the IRS states relief will automatically be granted if certain requirements are met (see right-hand box). This is available this year to estates of taxpayers who died after December 31, 2010 and before January 1, 2014. For purposes of electing portability, the taxpayer’s Form 706 will be treated as being timely filed. Also, the taxpayer will receive a letter acknowledging receipt of Form 706.
The new procedures don’t apply to taxpayers who filed an estate tax return within the prescribed time. Those taxpayers either will have elected portability of the DSUE amount by timely filing that estate tax return or will have affirmatively opted out of the portability.
Moral of the story: After a long period of uncertainty, taxpayers can take advantage of favorable estate tax rules, including the portability provision. These changes should be incorporated into a comprehensive estate plan taking all the relevant factors into account. Consult with an experienced estate planner to maximize the portability provision and other benefits allowed under the law.