Late Portability Election: New Relief Available

Late Portability Election: New Relief Available

The IRS has just changed the timeframe for filing a late portability election for federal estate tax purposes. This is extremely important to those who did not timely file a federal estate tax return (Form 706) when the first spouse died.

By Robert S. Barnett and Gregory L. Matalon

The IRS has just changed the timeframe for filing a late portability election for federal estate tax purposes. This is extremely important to those who did not timely file a federal estate tax return (Form 706) when the first spouse died. Previously, the IRS only allowed a late portability filing (in certain circumstances) within two years of death—this change extends the filing period to five years from date of death. Prior to this recent change, if Form 706 was not filed the executor would have to request special dispensation from the IRS: a private letter ruling request, which was costly and not guaranteed.

Background

Each U.S. citizen and U.S. resident is entitled to federal estate and gift tax exemptions of $12,060,000 in 2022. Prior to 2010, after a spouse died, complex planning and use of trusts was often necessary to secure the first deceased spouse’s federal estate exemption.  The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, provides relief for clients who fail to plan. The 2010 Act allows for the “portability” of the deceased spouse’s unused federal estate and gift tax exemption and was made effective for decedents dying and gifts made after Dec. 31, 2010.

In essence, portability allows the surviving spouse to utilize the available estate and gift exemption from the deceased spouse, without the use of complicated trusts and other planning mechanics. The 2010 Act refers to the “portable amount” as the deceased spousal unused exemption (often defined as DSUE).  DSUE is the lesser of the basic exclusion amount of the first deceased spouse; or the excess of the applicable exclusion amount of the last deceased spouse over the amount with respect to which a tentative tax is determined. While this definition is confusing, the following example provides clarity:

A spouse dies in 2022, having made no lifetime gifts and with a last will and testament that provides all assets pass to the surviving spouse. The surviving spouse will have the benefit of decedent’s full $12,060,000, to use during the life of the surviving spouse to make gifts, and the remaining exemption amount can be used by the executor of the surviving spouse’s estate to reduce the estate tax, even when the surviving spouse dies after 2026, which is when federal estate tax exemptions are reduced by one-half.

In order for the surviving spouse to utilize the remaining exemption of the first deceased spouse, the executor of the decedent’s estate must elect portability of DSUE on a timely-filed Form 706. Treas. Reg. §20.2010-2 states that the timely filed election is made with the Form 706 within nine months after the decedents date of death, or on the last day for the required filing if a proper extension of time has been obtained. The regulations state that the Form 706 must be properly prepared; however, special rules allow for streamlined reporting with respect to estates and transfers which are deductible under the marital deduction and/or charitable deduction provisions. The amount of DSUE portable to the surviving spouse is calculated and reported to the IRS on Form 706, page 4, Part 6, §C. Many estates will be able to utilize this streamlined reporting and are only required to report the description, ownership, and beneficiary of such property along with the executor’s best estimate of value. The reporting allows for a cost-effective method of preparing the Form 706.

Late Filing Relief

Many taxpayers failed to file Form 706 because the value of the first deceased spouse’s estate did not require such a filing. However, asset appreciation, together with assets owned by the surviving spouse, and the upcoming reduction to the federal estate and gift tax exemptions has many surviving spouses wishing to make late portability elections.

The IRS recently issued Rev. Proc. 2022-32 which extends the two-year relief period from Rev. Proc. 2017-34 to five years. The IRS has stated that the purpose of this new procedure is to reduce the number of private letter ruling requests, thereby alleviating a burden on the IRS and taxpayers. Under this simplified method the executor makes the portability election by filing a complete and properly prepared Form 706 on or before the fifth anniversary of the decedent’s date of death and placing on the top of the Form 706 “FILED PURSUANT TO REV. PROC. 2022-32 TO ELECT PORTABILITY UNDER SEC. 2010(c)(5)(A).” This procedure is extremely beneficial and will save the time and expense of filing a private letter ruling request. Decedents who were citizens or residents of the United States on the date of death are eligible to use this simplified method provided the gross estate was under the filing threshold. No user fee is required for returns filed under the Revenue Procedure, thereby making a late portability election cost-effective for taxpayers. Estates that have not elected portability on a timely-filed Form 706 or utilized Rev. Proc 2017-34, should consider filing under the new guidance.

Estates Beyond the Fifth Anniversary of Death

The Revenue Procedure clarifies that if the estate is not within the scope encompassed by the procedure due to the five-year election period (but not due to the size of the estate) the executor may request an extension of time to make the portability election by submitting a private letter ruling request under the provisions of Treas. Reg. §301.9100-3. From experience, private letter ruling requests for portability are generally granted favorable relief if the estate was under the required estate tax filing threshold. Due to the cost of obtaining the private letter ruling, many estates do not seek relief.

Example: Portability Election Tax Savings

Facts: H dies in 2019 having a taxable estate of $5,000,000 consisting of a residence valued at $1,750,000, an IRA of $500,000 and stocks and bonds of $2,750,000. Surviving spouse receives all of H’s assets pursuant to H’s will and/or beneficiary designation, and therefore H has no taxable estate. H’s estate is also under the federal estate tax filing threshold and the procedure under Rev. Proc. 2022-32 is available. H’s surviving spouse dies in January 2026 with a total estate of $8,000,000. No portability election was made.

Law: In 2019, the federal estate tax basic exclusion amount was $11,400,000. On Jan. 1, 2026, the federal estate tax exemption will be reduced by one-half (currently the federal estate tax basic exclusion amount is $12,060,000). As such, assume a 2026 federal estate tax exemption of $6,500,000.

Issue and Analysis: Should the executor of H’s estate file a Form 706 under the guidance provided in Rev. Proc. 2022-32? Without a portability election, the surviving spouse’s estate would be subject to a federal estate tax (at a tax rate of 40% and assuming no deductions) of $600,000.

The executor of H’s estate should file a federal estate tax return to elect portability. By electing portability, the federal estate tax at the surviving spouse’s death will be zero thanks to Rev. Proc. 2022-32.

If the surviving spouse lives in New York state, a state level estate tax (assuming no deductions) of $773,200, will be due. Note: For federal estate tax purposes the New York state estate tax is a deduction—thereby reducing the federal estate tax estimated above to $290,720, instead of $600,000.

While not a focus of this article, with pre- and post-mortem estate planning, including the use of a renunciation and a properly drafted credit shelter trust, the New York state estate tax calculated above can also be eliminated—a savings to the beneficiaries of the estate of $773,200. New York state does not have portability for the unused New York state estate tax exemption and the prior need for more complex planning is necessary.

Conclusion

Rev. Proc. 2022-32 provides a cost-effective method to file a Form 706 to make a late portability election. With increased client wealth and the reduction to the federal estate tax exemption on Jan. 1, 2026, attorneys and tax advisors should recommend portability for all current and older estates to reduce or eliminate federal estate tax. Attorneys should communicate these rules and document their client’s decision in their files.

Gregory L. Matalon (gmatalon@cbmslaw.com) is a trusts and estates partner at Capell Barnett Matalon & Schoenfeld. Robert S. Barnett (rbarnett@cbmslaw.com) is a tax and business partner at the firm.