New IRS Ruling May Rescue Estate Plans

November 6, 2017

President Trump’s campaign promise to abolish the federal estate tax may or may not be realized. Meanwhile, the “death tax” still exists, and it continues to be a major concern for high net-worth taxpayers, including the owners of successful small companies.

If a deceased taxpayer has a surviving spouse, the estate of the deceased spouse may make a portability election. If this election is made, the unused federal estate tax exclusion of the deceased spouse (called the deceased spouse unused exclusion, or DSUE) can be carried over to and used by the surviving spouse. The executor of the deceased spouse’s estate must make the portability election on a timely filed estate tax return that includes a computation of the DSUE.

IRS Revenue Procedure 2017-34, effective June 9, 2017, provides relief when a deceased spouse’s executor fails to make a timely portability election. The revenue procedure sets out a simplified method for requesting an extension of time to executors of certain estates of decedents who died after 2010 to make the election.

The portability extension offered by this revenue procedure would be until the later of January 2, 2018, or 2 years after the decedent’s date of death to make the election. Normally, the deadline is 9 months after death, or 15 months if the decedent’s estate requested an extension of time to file an estate tax return.

The new extension is permanent but applies only to estates of decedents who died after 2010, survived by a spouse, that are otherwise not required to file an estate tax return, except to make the portability election. In cases in which the surviving spouse died before a portability election was made, and the surviving spouse’s estate paid federal estate tax, a tax refund may result.

Doubling the exemption

The federal estate tax exemption has gradually increased from $5 million to $5.49 million in recent years. Thus, many estates have not owed this tax, and many executors have not filed a Form 706 federal estate tax return.

Example 1: Jim Cook died in 2012 when the estate tax exemption was $5.12 million. His estate was worth $4 million, all of which he left to his wife, Marie. Therefore, his executor was not required to file Form 706 and did not do so.

That could have been an error. Jim’s estate did not use any of that year’s estate tax exemption. By filing a Form 706, his executor could have elected portability of his DSUE. If the election had been made, Jim’s widow Marie’s estate could have used Jim’s DSUE in addition to her own at her death.

Example 2: Assume Marie dies in 2017 with a total of $8 million, including the assets inherited from Jim. Her estate would be over the $5.49 million estate tax exemption this year by $2.51 million. At a 40% estate tax rate, Marie’s estate would owe over $1 million to the IRS.

Now suppose that Jim’s executor had elected portability on Form 706. Because Jim had left all of his assets to Marie, his entire $5.12 million DSUE would be added to Marie’s $5.49 million exemption, for a total of $10.61 million. Marie’s $8 million estate would be under that threshold, and no federal estate tax would be due.

Filing the form

To obtain relief under Rev. Proc. 2017- 34 from the failure to make a portability election, all the executor must do is file a complete and properly prepared Form 706 estate tax return on or before the later of January 2, 2018, or two years from the decedent’s date of death. On this return, the executor should explain that it is being “filed pursuant to Rev. Proc. 2017-34 to elect portability under 2010(c)(5)(a).” If these requirements are met, the extension of time to elect portability will be granted, and the Form 706 electing portability will be considered to have been timely filed.

As previously noted, the IRS is providing this relief retroactively to estates of decedents who died after 2010, which have until next January 2 to obtain relief under Rev. Proc. 2017-34. Estates of decedents who died after January 2, 2016, have two years from the date of death. If the decedent’s surviving spouse has died, and the surviving spouse’s estate has already filed Form 706 and paid estate tax on which the statute of limitation on refund has not expired, the executor of that estate can file an amended Form 706, including the decedent’s DSUE, and get any resulting refund.

Good news for business owners

Rev. Proc. 2017-34 can benefit the estates of all wealthy decedents, but it may be especially valuable for business owners and their heirs. When the owner of a business dies, his or her interest in the company must be valued. A moderately successful firm can have a value well into seven or even eight figures. Counting the decedent’s other assets, the total can be in estate tax territory.

Generally, estate tax must be paid within nine months of death. In some cases, estates of the owners of closely-held companies may defer the tax over an extended time period. Still, the tax payments may be considerable, and the heirs of business owners may lack the liquid assets necessary for this obligation.

Such concerns might lead business owners and others into sophisticated tax planning tactics to deal with future estate tax. These tactics may be helpful, for various reasons, but the presence of portability may reduce the need, as a married couple now can easily pass on nearly $11 million worth of assets to the next generation with portability.