What is portability?
“Portability” is the term used to describe a surviving spouse’s use of the unused estate tax exclusion amount of a deceased spouse. Through application of the unified credit for estate and gift tax purposes to gratuitous transfers of wealth during life or at death, every US citizen and domiciliary may exclude from federal estate and gift taxation an aggregate amount of the value of those transfers. That amount, known as the basic exclusion amount, is currently at a historic high of $12,920,000 per person. Treas. Reg. §20.2010-1(e) (2019). At death, an individual who made no taxable gifts during life will have the entire basic exclusion amount remaining. An individual who made taxable gifts during life will have something less than the full basic exclusion amount remaining since a portion would have been applied to those lifetime gifts. In either event, the remaining basic exclusion amount, full or partial, will be available to apply against taxable transfers occurring at the individual’s death.
Taxable transfers at death usually are transfers to beneficiaries other than the surviving spouse or charity, since the estate tax law generally allows for the unlimited deduction from the gross estate of amounts passing to a spouse or charity. When a decedent is survived by a spouse, the decedent’s unused exclusion amount may be transferred to the surviving spouse and added to the survivor’s own exclusion amount. The amount of the deceased spouse’s unused basic exclusion is known as the deceased spousal unused exclusion amount, or “DSUE amount” under the applicable Treasury Regulations. The transferability of the DSUE amount to a surviving spouse is known as portability.
Prior to the federal tax law’s adoption of portability in 2010, each spouse’s federal estate tax exemption, through application of that spouse’s unified credit, was for the use of that spouse alone and not transferable to the survivor. Unused exemption was lost. In this pre-portability era, married couples often preserved the benefit of their respective exemptions by executing wills or revocable trusts that directed the predeceasing spouse’s unused exemption to a trust, often for the survivor’s primary benefit but structured in such a way that the trust assets would not be included in the survivor’s taxable estate, commonly called a unified credit trust or bypass trust. The adoption of portability was intended to simplify the process by which a couple may preserve the use of both exemptions without relying on these trusts. The required process reflects this goal of creating a simple, straightforward method by which a couple can use both exemptions without relying on trusts.
How does a surviving spouse use portability?
To elect portability of the DSUE amount, which is not automatic, the executor of the deceased spouse’s estate must file a timely and complete federal estate tax return, Form 706. This requirement applies to all estates making a portability election, including estates that are not otherwise required to file an estate tax return because the value of the gross estate, increased by the decedent’s aggregate lifetime taxable gifts, does not exceed the basic exclusion amount for the year of death. The executor completes Section C of Part 6 of Form 706 to calculate the DSUE amount that will be transferred to the surviving spouse. IRS, Instructions for Form 706 (2022), available at https://www.irs.gov/pub/irs-pdf/i706.pdf. As a general rule, Form 706 is due within nine months of the deceased spouse’s death, or fifteen months if an extension of time to file the return, Form 4768, is timely filed. I.R.C. § 6075(a); Treas. Reg. §20.6081-1(b) (2001).
Despite the relative simplicity of making a portability election, an executor who is not otherwise required to file a federal estate tax return may be reluctant to spend the time or incur the expense required to complete and file a return. Similarly, when a return is not otherwise required, the executor could simply overlook the requirement to file by the nine-month or fifteen-month deadlines and, without relief, lose the opportunity to claim this important benefit. Practitioners have requested a short form 706-EZ for cases where an estate tax return is filed only for portability purposes, but to date no short form return exists. Instead, the IRS has introduced two relief provisions since the advent of portability to simplify the filing of portability returns for surviving spouses: (1) a special rule relaxing the asset valuation requirements for estates making a portability election that are not otherwise required to file a return, and (2) a simplified method for extending the time to make the portability election. Treas. Reg. §20.2010-2(a)(7)(ii)(A) (2015); Rev. Proc 2022-32, 2022-30 IRB 101.
Special Relief for Portability Returns
A special rule for portability-only returns was granted through Treas. Reg. §20.2010-2(a)(7)(ii)(A). The regulation provides that the executor of an estate not otherwise required to file an estate tax return is not required to report the value of certain property qualifying for the marital or charitable deduction. For such property, the executor may estimate the value, include such estimates in the total value of the gross estate, and report in accordance with the instructions for Part 5 of Form 706. An executor making use of this option should check the box on Part 1, Line 11, indicating that the executor is estimating the value of assets included in the gross estate pursuant to this special rule. The rule requires that the executor report only the “description, ownership, and/or beneficiary of the property, along with all other information necessary to establish the right of the estate to the [marital or charitable deduction.]” The examples provided in the regulation provide clear guidelines regarding when the special rule may be used and when regular return requirements must be followed, including the description of circumstances where the use of both approaches is permitted and appropriate.
The special rule applies only if the executor makes the estimates exercising due diligence. In making the executor’s best estimate of the value of the specific property to which the special rule applies, the executor must report on the return, under penalties of perjury, the amount that corresponds to a particular range provided in a chart in Part 6 of the Instructions for Form 706 within which the estimate falls.
The simplified method provides useful relief to executors who wish to avoid the need for full fair market value appraisals of assets, but it is not available in all circumstances. Specifically, full and accurate valuations are required for marital or charitable deduction property subject to formula bequests, partial disclaimers or partial QTIP elections, and split-interest transfers.
Furthermore, when a return is completed using estimates, the surviving spouse will not have the return as a record for income tax basis purposes. The basis of inherited property will generally equal its fair market value on the date of death, a concept commonly referred to as the step-up in basis. I.R.C. §1014. When regular return requirements are used, the survivor may use the return as a consolidated record of basis. The relaxed reporting requirements remove that single reference point, but keep in mind that the filing of a return is not required to establish basis. When the special rule is used, an executor or surviving spouse should simply maintain sufficient separate records to substantiate date of death values and thus the survivor’s basis in those inherited assets.
Simplified Method for Extending Portability Election
Under Rev. Proc. 2022-32, the IRS enhanced relief first made available under Rev. Proc. 2017-34, 2017-26 I.R.B. 1282 (superseded by the 2022 Rev. Proc.) which had introduced a simplified method to extend the time to elect portability. This relief remains available only in cases in which a federal estate tax return is not required other than to make a portability election. In such circumstances, rather than file by the prescribed nine- or fifteen-month deadline, an executor may file a complete estate tax return on or before the fifth anniversary of the decedent’s date of death. When filing, the Executor must print at the top of the return: “FILED PURSUANT TO REV. PROC. 2022-32 TO ELECT PORTABILITY UNDER § 2010(c)(5)(A).”
Extending the simplified method to apply until the fifth anniversary of the date of death should substantially relieve the IRS’s burden in responding to a multitude of extension requests under Treas. Reg. § 301.9100-3 (1997) (so-called “Section 9100 relief”) for portability purposes. The five-year period also gives surviving spouses considerably more time to organize their affairs following the death of a decedent spouse and, notably, to evaluate the size of their own potential estates and determine whether they will benefit from the transfer of the DSUE amount.
Conclusion
Portability is a taxpayer-friendly concept and the IRS’s introduction of the reduced reporting requirements and simplified method for extending the election described above are helpful. But the simplified processes raise other issues for consideration. Executors should take care to accurately report the value of assets that do not qualify for the special rule, keep careful records for the purpose of establishing basis, and timely file estate tax returns that are required for reasons other than portability.
Reprinted with permission from the May 19, 2023 edition of The Legal Intelligencer © 2023 ALM Global Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-256-2472 or reprints@alm.com.