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Estate Taxes

Portability refers to the ability of a surviving spouse to make use of a deceased spouse’s unused estate tax exclusion amount.

By Nancy Burner, ESQ.

The estate tax concept known as “portability” is permanent as a result of the enactment of the American Taxpayer Relief Act of 2012. Portability allows a surviving spouse to use a deceased spouse’s unused estate tax exclusion (up to $5.49 million in 2017).

For those dying after Dec. 31, 2011, if a first-to-die spouse has not fully used the federal estate tax exclusion, the unused portion called the Deceased Spousal Unused Exclusion Amount, or DSUE amount, can be transferred or “ported” to the surviving spouse.

Thereafter, for both gift and estate tax purposes, the surviving spouse’s exclusion is the sum of (1) his/her own exclusion (as such amount is inflation adjusted) plus (2) the first-to-die’s ported DSUE amount.

For example: Assume H and W are married, and H dies in 2017. H owns $3 million and W owns $9 million in assets. H has the potential of leaving up to $5.49 million free from federal estate tax to a bypass or credit shelter trust. This would avoid federal estate tax in both spouses’ estates.

However, because H only has $3 million in assets, he does not take full advantage of the entire $5.49 million exclusion. Prior to portability, $2.49 million of H’s exclusion would have been wasted. With portability, his remaining $2.49 million exclusion can be saved and passed to W ‘s estate, increasing the amount she can leave her beneficiaries free from federal estate tax. With a 40 percent federal estate tax rate, this would save W’s estate approximately $996,000 in federal estate tax.

With this plan, the estate would also avoid New York State Estate Tax at the husband’s death since the current exclusion is $5.25 million. The assets in this bypass trust would escape federal and New York estate taxation at W’s subsequent death.

In order for the surviving spouse to be able to use the unused exemption, the executor of the first-to-die’s estate must make an election on a timely filed estate tax return. A timely filed return is a return filed within nine months after death or within 15 months after obtaining an automatic extension of time to file from the IRS.

Normally a federal estate tax return is only due if the gross estate plus the amount of any taxable gifts exceeds the applicable exclusion amount (up to $5.49 million in 2017). However, in order to be able to elect portability, a federal estate tax return would have to be filed even if the value of the first-to-die’s estate was below the exclusion amount.

The problem occurs when the first spouse dies and no estate tax return was filed. In that event, the second-to-die spouse could not use the deceased spouse’s unused exemption. In the above example, the second spouse’s estate would have paid an additional $996,000 in federal estate tax if the election was not made. What if the first spouse dies, no estate tax return is filed, and no election was made on a timely basis? Does the surviving spouse lose the exemption?

In June 2017, the IRS issued Revenue Procedure 2017-34. The revenue procedure is a simplified method to be used to make a late portability election. The IRS is making this simplified method available for all eligible estates through Jan. 2, 2018. The IRS is also making the simplified method of this revenue procedure available after Jan. 2, 2018, to estates during the two-year period immediately following the decedent’s date of death.

To be eligible to use the simplified method under the revenue procedure the estate must meet the following criteria:

(1) The decedent: (a) was survived by a spouse; (b) died after Dec. 31, 2010; and (c) was a citizen or resident of the United States on the date of death.

(2) The executor was not required to file an estate tax return based on the value of the gross estate.

(3) The executor did not file an estate tax return within the time required.

(4) The executor either files a complete and properly prepared United States estate (and tax return) on or before the later of Jan. 2, 2018 or the second annual anniversary of the decedent’s date of death.

For those that had spouses pass away after Dec. 31, 2010, portability can be a valuable estate planning tool to save a significant amount of federal estate tax on the death of the second spouse.

If a surviving spouse has assets that are close in value to the current federal exclusion amount, it is important to examine the records of the deceased spouse to make sure that a portability election was made on a timely filed federal estate tax return. If no return was filed, and no estate tax return was required to be filed, based upon this IRS revenue procedure it’s still not too late to elect portability. The surviving spouse must act quickly as the deadline is fast approaching and 2018 will be here before we know it.

Nancy Burner, Esq. practices elder law and estate planning from her East Setauket office.

By Linda Toga, Esq.

THE FACTS: After my mother’s death, my father met a woman, Mary, who was his partner for many years. They lived in my father’s house, which has a value in excess of $3 million. In his will my father left the house to Mary. He also named Mary as the beneficiary of his life insurance policy, which has a death benefit in excess of $2 million. He left his residuary estate to me and my sister. However, the will states that any estate taxes that may be owed are to come out of his residuary estate. My concern is that paying the estate taxes will likely deplete the residuary estate, leaving my sister and me with nothing.

THE QUESTION: Is there some way we can compel Mary to pay the estate tax from the funds she is receiving? It does not seem fair that we may be paying the taxes on the assets which she will be enjoying.

THE ANSWER: Since your father clearly intended for you and your sister to be beneficiaries of his estate, it appears that he may not have understood which of his assets would be considered in calculating his estate’s tax liability.

If, for example, your father and Mary were married at the time of his death, the value of the assets passing to Mary would be excluded from the value of the estate used to calculate the estate tax liability. That is because there is an unlimited marital deduction that applies when determining whether or not federal or New York state estate tax is due.

It is possible that your father believed the exclusion would apply based upon the fact that he and Mary were living together as husband and wife. Unfortunately for you and your sister, the taxing authorities do not see it that way.

Another possibility is that your father assumed that the death benefit from his life insurance policy would not be included in his gross estate for estate tax purposes. That is a common misconception that often leads to an unexpected tax liability.

Estate taxes are calculated based upon the value of all the assets owned or controlled by an individual at the time of death. Since your father could have changed the beneficiary listed on his life insurance policy up until the time of his death, he had “control” over the $2 million death benefit. For that reason, the value of the death benefit is included in his estate for purposes of calculating the estate tax owed.

It is noteworthy that some people actually buy life insurance so that the death benefit can be used to cover the estate taxes that may be assessed against their estates. By doing so, the decedent provides his beneficiaries with liquid assets that can be used to pay any estate taxes that are assessed against the estate. This, in turn, eliminates the possibility that the beneficiaries may need to sell estate assets just to pay the estate tax.

Even if your father was aware of how the estate tax would be calculated, he may not have realized that his will dictated that all of the taxes be paid from his residuary estate. If that fact had been explained to your father, he may have chosen to apportion the estate tax liability between all of the beneficiaries of his estate.

By apportioning the taxes that were due, Mary would be responsible for the taxes attributed to the value of the house, for example. That would have certainly decreased the amount of taxes being paid from the residuary estate earmarked for you and your sister.

In light of the fact that your father’s will does not provide for the apportionment of the estate, the full tax liability will be paid from the residuary estate unless Mary is willing to pay some or all of the estate tax assessed against your father’s estate. If she is not willing, there is nothing the executor of the estate can do but pay the taxes in accordance with the provisions of the will.

The amount of the estate tax due from your father’s estate will depend on when your father died since the exclusion amount on both the federal and New York state estate tax has been increasing annually for a number of years.

Since April, 2017, the exclusion amount for both federal and New York state estate tax exceeds $5.2 million. Even without apportionment, there is a chance that no estate tax will be due unless the value of your father’s estate exceeds the current exclusion amounts. If it does not, the full amount of the residuary estate will pass to you and your sister without any tax liability.

Linda M. Toga, Esq. provides legal services in the areas of estate planning, probate, estate administration, litigation, wills, trusts, small business services and real estate from her East Setauket office.