Executive Summary
The potential for portability of a deceased spouse's unused exemption amount (DSUEA) to a surviving spouse was a significant change that emerged from the fiscal cliff legislation in 2010. However, early adoption of portability was limited, due both to a lack of awareness of the rule by many of those who needed it, and the fact that the portability rules were just "temporary" and faced future sunset in the fiscal cliff of 2012 until subsequently made permanent under the Taxpayer Relief Act of 2012... and by that time, it was already too late for many who might have wished to claim portability.
To provide relief for this unfortunate situation, the IRS has issued Revenue Procedure 2014-18, which will allow any decedent who passed away in 2011, 2012, or 2013 to have an extension to file an estate tax return and claim DSUEA portability for the surviving spouse. However, the relief provision reopening portability for anyone who died in the past 3 years is temporary; the Form 706 estate tax return must be filed by the end of 2014 to claim this "retroactive" portability, or the window will once again be closed for good.
For many surviving spouses, this opportunity for retroactive portability is an appealing relief provision to get a "free" second chance to claim portability and carry over a decedent's unused estate tax exemption amount; the only requirement is that a Form 706 estate tax return now be filed. In situations where the surviving spouse has also since passed away, the potential for retroactive portability could actually result in an immediate and significant estate tax refund. And notably, for same-sex spouses - who couldn't file for portability in 2011, 2012, or most of 2013 because the marriage wasn't recognized in the first place - the new relief provisions of Rev. Proc. 2014-18 offers the opportunity to go back and claim portability for a same-sex surviving spouse who never had the opportunity in the first place!
Understanding Portability Of The DSUEA
The rules allowing portability of a deceased spouse's unused exemption amount (also known as DSUEA, or the "DSUE amount") to a surviving spouse under IRC Section 2010(c) were first created as a part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, also known as TRUIRJCA or the first fiscal cliff legislation. Under the portability rules, the surviving spouse was eligible to carry over the decedent's unused estate tax exemption simply by having a timely estate tax return filed (generally within 9 months of death, plus a potential 6-month extension) for the decedent's estate. Notably, though, the Form 706 Federal estate tax return was required to be filed to elect portability, even if there was not otherwise an estate tax liability or any other reason/requirement to file an estate tax return. The new rules applied for any decedents who passed away beginning in 2011 (i.e., deaths that occurred after December 31st, 2010).
Unfortunately, though, many people did not take advantage of portability in the early years. In some cases, this was simply because the decedent didn't realize that the portability rules existed and that filing a return was required; after all, the rules took effect for deaths on/after January 1st of 2011, after having just been passed into law less than 3 weeks earlier. And by definition, the portability rules applied primarily for those who had no estate tax exposure, and didn't otherwise have to file an estate tax return, which means there wasn't necessarily an attorney or accountant even involved in the process.
Even for those where an attorney or accountant may have been involved, there was still a challenge of trying to decide whether it was worthwhile to go through the cost of filing a Form 706 estate tax return to claim portability, given that the provisions of TRUIRJCA - including the new portability rules - were scheduled to lapse after two years. As long as portability was temporary, its applicability was very limited; it would only apply if the first spouse died on/after January 1st of 2011 (when the rules took effect), and the second spouse died by December 31st of 2012 (before the rules lapsed).
With the passage of the American Taxpayer Relief Act to resolve the fiscal cliff of 2012, though, the landscape changed again; portability was made permanent, making it permanently relevant for all taxpayers and estates who might possibly want to carry over the estate tax exemption. However, finding out that portability was permanent at the start of 2013 was already too late for many, who didn't find out that the rules were permanent until the filing deadline had already passed. For others, claiming portability earlier hadn't even been an option; for instance, when the Supreme Court struck down Section 3 of DOMA in United States v. Windsor and the IRS subsequently declared in Revenue Ruling 2013-17 that it would recognize same-sex marriages for Federal income and estate tax purposes, in some cases a same-sex widow(er) couldn't go back to file an estate tax return to claim portability because the deadline had already passed before even becoming aware the marriage would be recognized!
Portability Relief Under Revenue Procedure 2014-18
On January 27th, 2014, the IRS issued Revenue Procedure 2014-18, creating a new opportunity for estates to go back and file an estate tax return to claim portability of a decedent's estate tax exemption. Technically, the new rules grant estates a way to claim an extension under Treasury Regulation 301.9100-3 for filing an estate tax return, while extends the time window in which portability can be elected. Thus, even those who are otherwise beyond the normal 9-month filing time window (and the 6 month extension) can go back and file an estate tax return to claim portability.
In order for the portability relief to apply, Revenue Procedure 2014-18 stipulates the following requirements:
1) The decedent must have:
a) Had a surviving spouse at the time of death
b) Died after December 31, 2010, and on/before December 31, 2013
c) Been a U.S. citizen or resident at the time of death
2) There must not have otherwise been a requirement to file an estate tax return (i.e., per IRC Section 6018 the decedent's estate was under the estate tax exemption amount so there was no requirement to file; if it is later determined that the gross estate was large enough that an estate tax return should have been filed in the first place, this part of the requirement is not satisfied)
3) An estate tax return was not otherwise filed already (if an estate tax return was filed and portability was elected it's a moot point, and if the decedent's estate specifically opted out of portability, it can't be undone at this point)
If the above requirements are met, the decedent's estate can retroactively claim portability by simply going ahead and now filing a proper Form 706 Federal estate tax return. The return must be filed by December 31st, 2014, to take advantage of the rule. Normally, under the normal rules for portability, no further election is necessary to claim portability, and the mere act of filing the return itself, and not specifically electing out of portability is sufficient to claim a carryover of the DSUEA to the surviving spouse. However, with this relief provision, if the Form 706 Federal estate tax return is specifically being filed retroactively to claim portability, the IRS indicates that the following should be written across the top of the return: "FILED PURSUANT TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER IRC SECTION 2010(c)(5)(A)". If the form is properly and timely filed, the IRS will provide an estate tax closing letter to acknowledge receipt of the Form 706.
Those who don't meet these requirements to obtain an extension for filing an estate tax return to retroactively claim portability (or who fail to file by the new December 31st, 2014 deadline) are still allowed to apply for a Private Letter Ruling directly with the IRS to request relief (albeit with its expensive up-to-$10,000 user fee!). However, the IRS also notes that it will not respond to letter rulings until 2015 for any estates that would be eligible to follow these rules. For those who had already submitted a PLR request for relief, the IRS states that the PLR can be withdrawn and the user fee will be refunded, if the decedent's estate wishes to simply rely on these rules instead.
Estate Planning Implications Of Portability Relief
By definition, these new rules providing portability relief are only relevant for situations where someone passed away in the 3-year time window of 2011, 2012, or 2013. Nonetheless, with Revenue Procedure 2014-18, any widow(er) who had a spouse pass away in the 2011-2013 time frame should at least consider going ahead and filing an estate tax return to claim portability.
Arguably, the only reason not to go ahead and file for portability under the new relief provisions is simply if the surviving spouse is so unconcerned about potential Federal estate tax exposure in the future that he/she doesn't want to go through the cost of filing the return... despite the fact that the cost should be relatively low given that the IRS currently even allows for "simplified" reporting under Treasury Regulation 20.2010-2T(a)(7)(ii), where no detailed appraisals for illiquid assets (e.g., the primary residence) are necessary and estimated values rounded to the nearest $250,000(!) are sufficient. Granted, in many situations assets and net worth are low enough that there is no realistic possibility that the surviving spouse's net worth will grow above the current $5.34M estate tax exemption (which itself is indexed for inflation and rises over time). On the other hand, in a world where "anyone" can win the lottery, and younger clients who are still working can potentially accumulate significant wealth over time, advisors who discuss retroactive portability and decide not to proceed should be certain to document the discussion and conclusion in their client notes.
In some situations, a spouse may have passed away within the time window and the second spouse may have also died thereafter; in this situation, if the second spouse had an estate tax liability, it's known that there will be a need and desire to go back and claim portability for the first estate, so that the DSUEA can be used in the second estate. For instance, if Harold passed away in early 2011 and left all his assets to Maude, and Maude subsequently last year in 2013 with an $8,000,000 estate (when the estate tax exemption was then only $5,250,000), it will clearly be desirable to file an estate tax return for Harold to claim portability. As it stands, Maude will be subject to a 40% Federal estate tax rate on the last $2.75M of her estate for a liability of approximately $1.1M, but if she was able to carry over Harold's $5M DSUEA from 2011, her estate tax exposure would be reduced to $0! The IRS guidance in Rev Proc 2014-18 does allow for this in situations where both spouses died (as long as the first spouse died within the time window and the rules are otherwise followed); if the second spouse's return was already filed and a tax was paid, a claim for refund must be filed by the later of three years after the return was filed or two years after the estate tax was paid, and if the time window(s) are nearly up the second spouse's estate can file a protective claim for refund if necessary while the first decedent's return is now filed.
It's also notable that this portability relief is applicable for same-sex married couples who were legally married but could not file an estate tax return to claim portability to a surviving spouse because the same-sex marriage was not recognized under Federal income and estate tax law until the IRS issued Revenue Ruling 2013-17 last year after the Supreme Court's decision in United States v. Windsor that struck down Section 3 of DOMA. Nonetheless, given that the IRS does now recognize the marriage - assuming it really was a legally recognized marriage under state law at the time - the opportunity for a surviving same-sex spouse to file for portability is now available, along with the potential to file a refund claim if the first spouse had owed estate taxes at death due to the lack of a spousal deduction, and if the second same-sex spouse also already passed away and owed estate taxes but now wishes to claim a refund given the availability of portability.
Ultimately, as noted earlier, some surviving spouses may simply decide that their net worth is low enough that they're not realistically likely to be subject to estate taxes, regardless of portability of the exemption. Nonetheless, for those who know they will be subject to future Federal estate taxes, or merely fear that they might be - as well as situations where the surviving spouse already passed away and really was subject to estate taxes - the new rules under Rev. Proc. 2014-18 provide significant relief. At a minimum, every surviving spouse who became a widow(er) in the 2011-2013 time frame should at least carefully consider whether it's worthwhile to file a simplified Form 706 estate tax return to claim portability, while the time window remains open until the end of 2014.
Great analysis. This could be “found money” for the children of many middle-class baby boomers whose widow or widower parent will see their estate grow in the future. The point is that these people typically aren’t even thinking about estate tax issues now.