June 27, 2012
Authored by: Caitlin Murphy and Tanya Harvey
As discussed previously on this blog, the Tax Relief, Unemployment Reauthorization, and Job Creation Act of 2010 (the “2010 Act”), signed into law on December 17, 2010, authorized portability of a married decedent’s unused estate tax exclusion to the decedent’s surviving spouse. The Treasury issued proposed and temporary regulations providing guidance on the requirements for electing portability and on the applicable rules for a surviving spouse’s use of the deceased spousal unused exclusion amount (“DSUE amount”) on Friday, June 15, 2012. (This date of issuance is relevant, as June 15, 2012 marked the latest possible date on which Treasury could file these temporary regulations so that they would apply retroactively to estates of decedents who died before they were issued.) What follows is a brief summary (in question and answer format) of some of the guidance provided by these new regulations.
When and how is the election made? Every estate electing portability (regardless of the size of the estate) must do so by filing an estate tax return (Form 706) within 9 months of the decedent’s death (or later, if an extension for filing has been granted). The Internal Revenue Code (“Code”) does not specify a filing due date for estates below the filing threshold. But the regulations conclude that a uniform filing requirement for all estates is appropriate, for purposes of making the portability election. This is regarded as consistent with legislative intent and beneficial for the IRS and taxpayers alike, because the records required to compute and support the DSUE amount are more likely to be available at the death of the predeceased spouse whose estate is making the election than when the surviving spouse makes a gift or dies. The portability election only becomes irrevocable, however, on the due date of the estate tax return, as extended. Thus, before that due date, an electing executor may supersede a previously-filed portability election on a subsequent, timely-filed estate tax return.
This is consistent with IRS Notice 2011-82 issued in September, 2011, with instructions for making the portability election.
Who is responsible for making the election? The deceased spouse’s executor, not the surviving spouse, is responsible for making the election. If no executor is appointed, then any person in “actual or constructive possession” of the decedent’s property (a “non-appointed” section 2203 executor, which might be the decedent’s surviving spouse) may file an estate tax return to elect portability.
How is the DSUE amount computed? The executor making the portability election must compute the DSUE amount. The IRS will update the form 706 to include a space to compute this but, until the form is updated, the IRS will deem a “complete and properly-prepared” return (one that contains all the information required to compute a decedent’s DSUE amount) to meet the computation requirements. Estates filing the old form 706 need not supplement or amend those returns after the form 706 is updated.
What is the scope of the “Last Deceased Spouse” limitation? The DSUE amount of a surviving spouse’s “last deceased spouse” is included in determining the surviving spouse’s applicable exclusion amount for gift and estate tax purposes, to the extent the executor of the last deceased spouse’s estate elected portability. The term “last deceased spouse” means “the most recently deceased individual who, at that individual’s death after December 21, 2010, was married to the surviving spouse.”
If a surviving spouse is predeceased by multiple spouses, it is the surviving spouse’s most recently deceased spouse that matters, even if that most recently deceased spouse’s estate did not make a portability election, or if that most recently deceased spouse had no remaining exclusion amount. In either of those cases, there would be no DSUE amount available to the surviving spouse and the surviving spouse would be barred from using a prior deceased spouse’s DSUE amount for purposes of calculating the surviving spouse’s applicable exclusion amount.
Favorably, however, the regulations also clarify that neither remarriage nor divorce from a subsequent spouse will sever a “last deceased spouse” relationship. A surviving spouse is entitled to the DSUE amount of a previously deceased spouse until any new spouse dies – so the last deceased spouse’s DSUE amount is not lost if the surviving spouse remarries (or remarries and subsequently divorces) or survives a new spouse.
A special “ordering” rule applies if a surviving spouse has multiple predeceased spouses and applies the DSUE amount of any predeceased spouse to inter vivos transfers made by the surviving spouse before surviving a subsequent spouse. Thus, the DSUE amount available to a surviving spouse (or a surviving spouse’s estate) includes both (1) the DSUE amount of the surviving spouse’s last deceased spouse and (2) any DSUE amount actually applied to taxable gifts made by the surviving spouse during the surviving spouse’s life to the extent the DSUE amount so applied was from a decedent who is no longer the last deceased spouse. In other words, a surviving spouse may use the DSUE amount of a predeceased spouse against gift tax liability as long as the DSUE amount is from the surviving spouse’s last deceased spouse, as determined at the time of the transfer. There is no corrective adjustment or increase in gift or estate tax liability for gifts made by the surviving spouse using the last deceased spouse’s DSUE amount, even if the surviving spouse remarries and survives a subsequent spouse (who would then become the last deceased spouse of the surviving spouse). The surviving spouse cannot accumulate multiple DSUE amounts of multiple predeceased spouses, because the remaining DSUE amount of a prior deceased spouse is lost once the surviving spouse is predeceased by a subsequent spouse.
The example provided in section 20.2010-3T(b)(2) of the new regulations confirms this taxpayer-favorable “ordering rule.” It provides that the DSUE amount of the surviving spouse’s last deceased spouse is applied first to any amount transferred by the surviving spouse before the surviving spouse’s own exclusion is used. This ordering rule makes it possible for a surviving spouse to take advantage of the DSUE amount of the last deceased spouse, as long as the DSUE amount was received from the surviving spouse’s last deceased spouse at the time of the transfer. The fact that the spouse is or may be remarried does not matter – provided that the gift occurs before any new spouse dies.
When is the last deceased spouse’s DSUE amount available to the surviving spouse? The last deceased spouse’s DSUE amount is available to the surviving spouse (or the surviving spouse’s estate) immediately after the deceased spouse’s death, provided that the deceased spouse’s estate makes a portability election. In essence, the spouse’s use of the DSUE amount relates back to the last deceased spouse’s death. However, an exception applies if a QDOT was created for the surviving spouse. In these cases the DSUE amount is computed on a preliminary basis, and then recomputed after assets held in the QDOT are subjected to taxation (as taxable distributions are made and when the surviving spouse dies), because QDOT taxation is the settlor’s liability, meaning that the DSUE amount cannot be known until after these triggering events. For that reason, in these cases the DSUE amount is not available to the surviving spouse until the occurrence of the final triggering event.
Is there any limit to the scope of the IRS’s authority to examine the returns of the deceased spouse? The IRS may examine the return of any deceased spouse of a surviving spouse to determine the allowable DSUE amount, even after the section 6501 period of limitation that usually applies to an estate tax return has expired. However, the IRS may only adjust or eliminate the DSUE amount reported on a return; the IRS may not assess additional tax with respect to the deceased spouse’s return after the generally applicable limitation period has expired.
May non-U.S. citizen spouses take advantage of portability? Because portability applies under section 2010, the portability election is unavailable to the executor of the estate of a nonresident decedent who was not a U.S. citizen at the time of death. Similarly, a nonresident surviving spouse who was not a citizen of the United States may use the DSUE amount of any predeceased spouse only to the extent allowed under a treaty obligation of the U.S. In each case section 2102 would apply, not section 2010, which means that portability is not available. However, a nonresident, non-U.S. citizen surviving spouse can work around this rule by becoming a U.S. citizen as long as his or her last deceased spouse was a U.S. resident or citizen.
Additional requests for comments. The Treasury Department and the IRS requested comments regarding two issues. The first is whether the DSUE amount should be determined before or after taking into account other tax credits that may be available to the decedent’s estate (for example, the credit for tax on prior transfers and the credit for foreign death taxes). The second relates to the approach adopted in the regulations regarding application of the portability rules when a qualified domestic trust (QDOT) is created for the benefit of a surviving spouse who is not a citizen of the United States, as discussed above.