The Internal Revenue Service recently announced a change in their procedures that might seem to be of purely clerical interest.

Heretofore, after someone’s estate has filed Form 706, which is used to figure the decedent’s estate tax, the IRS has sent a closing letter to signal the filing has been accepted and that federal tax liabilities have been satisfied. That generally allows the executor to finish off the disposal of the estate.

But as of this past summer, the IRS will only issue such letters upon the taxpayer’s request. This new rule applies to any estate tax returns filed after June 1 of this year.

Apparently, the new portability rules have created a flood of estate tax returns — more than the IRS was prepared to handle. Treasury Regulations require that an estate tax return be filed for an estate using the portability option for an estate exemption, even if there is no estate tax due and the estate is otherwise below the estate tax threshold.

The upshot is that what had once been a routine courtesy is now something that you or your clients will have to make a special request for. And the ramifications of this go beyond simple paperwork.

So what happens now? For those who may be paying estate tax, the new rules make things a bit more complicated. An estate closing letter can’t even be requested until four months after Form 706 has been filed.

According to the IRS’s “Frequently Asked Questions on Estate Taxes,” estates can expect a closing letter to be issued within four to six months from the date that Form 706 has been filed as long as the return has no errors and no special circumstances apply. If the return is being examined for other purposes, the letter could take even longer.

That means that taxable estates may have to delay their distributions to beneficiaries even more than the customary lag planners have gotten used to under the old rules.

On the other hand, estate planners don’t want to chase after a closing letter unless it is entirely warranted. The IRS generally won’t reopen a case when a closing letter is issued upon the request of an executor.

There has to have been something like fraud or a significant error on the part of the IRS. So getting a closing letter just for it’s own sake may not be helpful.

An estate that doesn’t receive an expected estate closing letter likely means that the estate is being audited for a potential estate tax assessment or will receive a Statutory Notice of Deficiency. That would mean the IRS has a specific concern about something reported on the Form 706. In either case, it’s going to prevent the estate from being disbursed for a while.

For portability issues, there is much less haste required in receiving the letter, unless the surviving spouse is in very poor health. But some heirs may wish to file for a closing letter in these cases anyway. If the portability election were denied due to a late filing, as long as the estate met the necessary thresholds, a closing letter would still be issued. So the letter would provide a final ruling on the portability of the exemption, which would provide peace of mind to the client, if nothing else.

Reminder: This affects only the IRS. States that collect an estate or inheritance tax will still issue a closing letter, signaling that the return has been reviewed and accepted by the state’s taxing authority.

One other concern: Blogger and financial planner Michael Kitces also notes that under the new rules, requesting a closing letter may light a fire under the IRS. He points out that if an estate doesn’t request a closing letter, the IRS may feel that reviewing those estates with promptness (especially if they may not reach the filing threshold) isn’t worth it.

Since the IRS hasn’t disclosed anything about how all this will be carried out, it remains to be seen if that will be the case. This may seem like a minor change to the estate planning process, but with so much still up in the air, wise estate planners will keep an eye on how the new rules play out.

 

Read also thee articles by Tom Nawrocki:

529 plans vs. life insurance: 7 questions to ask clients

Opportunities aplenty: Advising parents on college funding

The end of the back-door Roth? Time for a chat with clients

Protecting a no-contest clause: What you need to know

Dealing with out-of-state property issues in estate plans