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Today’s generous estate tax exemption has created an unexpected problem among clients: failure to take advantage of the portability of a first-to-die spouse’s unused estate tax exemption. Unknown to many, portability is available only if you ask for it, and failure to elect portability can leave a surviving spouse’s estate facing an unexpectedly heavy tax burden, even if no estate tax was due upon the first spouse’s death. Luckily, the IRS has provided a limited reprieve for certain clients whose inadvertent failure to make the election could leave them on the hook for an unnecessary estate tax bill. The relief provided by the IRS, however, is limited in both time and scope, so the time to learn the rules of portability is now.
The Rules of Portability
Portability simply allows a surviving spouse to make use of both his federal estate tax exemption and the exemption granted to a first-to-die spouse. Because every decedent is allowed an exemption of $5.34 million in 2014, this allows a married couple to shelter a combined $10.68 million from any federal estate tax liability.
This generous estate tax exemption, however, can often cause a problem for surviving spouses when the entire estate of the first-to-die spouse is sheltered from estate tax. Clients and advisors alike commonly overlook a key requirement for obtaining the benefits of portability: you have to ask for it. Even if no estate tax is due upon the death of a first-to-die spouse, the executor of the estate must elect portability by filing an estate tax return on Form 706 within nine months of death (a six-month extension is available if necessary).
Failure to make the election can eventually cause the estate of the second-to-die spouse to bear the entire tax burden, especially because the surviving spouse often inherits the bulk of a deceased spouse’s estate, thereby increasing the value of his own estate. While many clients may believe that the value of their estate could never exceed the $5 million mark, they may be overlooking the fact that the value of the first-to-die spouse’s estate will be included in—and potentially taxed with—their own eventual estate.
Revenue Procedure 2014-18
Because failure to elect portability has become common among the estates of decedents who either owe no estate tax upon the death of the first-to-die spouse or expect that a single $5 million (as indexed) exemption will be sufficient to shelter both estates, the IRS has granted an extension of time to allow retroactive portability elections. This extension can be especially useful to same-sex couples that have only recently become eligible to take advantage of spousal portability.
The relief provided by the IRS in Revenue Procedure 2014-18 is limited to situations where the estate of the first-to-die spouse was not required to file an estate tax return for any reason other than to elect spousal portability, meaning that it is limited to situations where the estate of the first-to-die spouse was completely sheltered from estate tax.
To take advantage of the extension, the first death must have occurred between Dec. 31, 2010, and Dec. 31, 2013. Further, the deceased must have been a U.S. citizen or resident who was survived by a spouse. To make the retroactive election, the surviving spouse must file Form 706 with the IRS by Dec. 31, 2014, and state that the filing is being make pursuant to Revenue Procedure 2014-18 in order to elect portability under IRC Section 2010(c)(5)(A).
Without this relief, the only way that a client can retroactively gain the benefits of portability is to request a private letter ruling from the IRS—a procedure that can prove time consuming and costly. Therefore, clients meeting the specific criteria developed by the IRS should be advised to retroactively elect portability before the deadline even if they are uncertain whether their estate will exceed the applicable exemption amount.
Originally published on National Underwriter Advanced Markets. National Underwriter Advanced Markets is the premier resource for financial planners, wealth managers, and advanced markets professionals who provide clients with expert financial and retirement planning advice.
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