New Portability Rules for Estate Taxes: A Simplified Opportunity

Posted by Justin C. Duft, JD, CFP, CLU, ChFC, CLTC

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November 14, 2017 at 10:00 AM

new portability rules for estate taxesLooking for a way to help clients simplify their estate taxes, especially after the death of a spouse? The IRS’s new portability rules for estate taxes may be just the opportunity your clients need. The agency’s recently released Revenue Procedure 2017-34 allows for a deceased spouse’s unused exclusion amount to be transferred to the surviving spouse retroactively, offering the potential for substantial savings.

What Prompted the Change?

These new rules come after the IRS was overwhelmed with requests for relief because so many people missed deadlines for electing portability. Before this change, executors had just nine months to elect portability on an estate tax return. Many of them were unaware they could make this election at all, especially if the estate was under the exclusion amount for filing an estate tax return. Once they realized they missed the deadline and wanted to request relief, executors would have to follow the costly and time-consuming process of securing a private letter ruling (PLR). With such high demand for relief, the IRS realized it had to simplify the rules.

How Do the New Rules Work?

There are a number of specifications to be aware of with the new Revenue Procedure 2017-34:

  • The procedure applies to taxpayers who died in 2011 or later.
  • It applies only to estates that were not required to file an estate tax return because their value was under the applicable threshold.
  • It does not apply to estates that filed a return but simply failed to elect portability; those estates must continue to seek individual relief from the IRS through a PLR.
  • It has a limited shelf life. Eligible estates will be able to retroactively file the tax return and elect portability only until the latter of January 2, 2018, or the second anniversary of the decedent’s date of death.

Rethinking Estate Planning in Light of Portability

Since the lifetime exclusion was increased to $5 million in 2010, the number of estates exposed to federal estate tax liability has decreased significantly. The combined exclusion between spouses, which today is $10.98 million, has caused many clients to rethink the strategies employed in their estate documents.

The most common question I hear is, “Since the portability rules for estate taxes allow us to transfer the unused exclusion, do I still need this AB trust?” This can be tricky to answer and depends on a couple of factors:

  • If the estate is likely to grow and exceed the exclusion amount, then the existing planning may still make sense.
  • If the estate is below the $10.98 million threshold and unlikely to ever exceed it, the answer is maybe.

This second point is important. Many states levy their own estate tax. Massachusetts, for example, has an exclusion amount of $1 million before the estate is subject to estate taxes. This exclusion is not portable between spouses, so it is a use-it-or-lose-it proposition. For estates exposed to state-level taxes, the AB trust design may still be effective.

Leveraging the Change with Clients

By having a handle on the latest rules and options, you can set up your clients for maximum flexibility. Take a look at the following example scenario to see how additional planning with the new portability rules for estate taxes in mind could benefit a surviving spouse.

The scenario. Massachusetts residents Mary and John had a combined estate of $2.5 million ($1.25 million in each name) when John died in 2015. His $1.25 million passed to Mary under the unlimited marital deduction. Mary didn’t file a federal estate tax return because the estate was well under the federal threshold. Since John’s death, the real estate they held has become extremely valuable because of new land development. Her $2.5 million estate has ballooned to $6 million, exposing her to federal estate taxes.

The solution. What type of planning could Mary and John have done to minimize estate tax exposure on the federal and state level? Either through their wills or with the use of revocable trusts, John could have included a provision that passed all assets to Mary under the unlimited marital deduction . . . unless she disclaimed. If she disclaimed, the assets would pass to an irrevocable trust designed to provide income to Mary for her lifetime. When John died, Mary could have disclaimed up to the $1 million Massachusetts exclusion so that she didn’t lose it. The other $250,000 would have passed to Mary outright. Disclaiming the $1 million would also remove the subsequent appreciation from her estate.

Remember that when John died, the estate didn’t need to file a tax return. With Revenue Procedure 2017-34 in place, Mary could still file the return and elect portability. This would add $5.43 million (lifetime exclusion in the year of John’s death) to Mary’s $5.49 million, giving her $10.92 million against federal liability at death.

Next Steps

As advisors, we constantly look for opportunities to help our clients. The underpublicized Revenue Procedure 2017-34 gives us the ability to do just that. As an exercise, try to identify any clients who have passed since 2011. If the surviving spouse has substantial assets and may be exposed to federal estate taxes, filing the estate tax return and electing portability at this point may make sense.

What opportunities do you see to help your clients after learning about the new portability rules for estate taxes? Have any of your clients already benefited from this change? Please share your thoughts with us below.

Commonwealth Financial Network® does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.

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