Pay early, pay less: maximizing TPT credit availability for married couples.

• Author: Pratt, David
• Position: Transfer of property tax

Section 2013 of the Internal Revenue Code (1) allows a federal estate tax (FET) credit in situations in which the decedent (referred to herein as the "transferee") received, either 10 years before or two years after death, property in a transfer (from the "transferor") that was also subject to FET (TPT credit). While the intended purpose of the TPT credit is to avoid excessive taxation when successive deaths occur in a short period of time, well-drafted estate plans allow application of the TPT credit to result in FET savings for married couples when the transferee spouse dies within 10 years of the transferor spouse. (2) On its face, especially with a non-graduated flat estate tax rate of 40 percent, paying taxes on the first death appears to be a wash because the total property subject to tax in both estates will be the same. The "magic" occurs because, under a strict application of [section]2013, some of the surviving spouse's interests in the resulting trusts created under the first to die's estate plan--which are not includible in his or her gross estate (3)--actually generate the TPT credit. Therefore, a credit is given for property that, in actuality, does not add to the surviving spouse's gross estate, which has the effect of lowering the combined estate taxes paid by the spouses.

TPT Credit Mechanics

The starting point when calculating the TPT credit is determining whether the transferor has "transferred" to the transferee any "property" included in the transferor's gross estate (transferred property). Treas. Reg. [section]20.2013-5(b) provides an open-ended definition of "transfers," which includes, but is not limited to, receipts of property: 1) under dower or curtesy; 2) as surviving joint tenant via survivorship rights; 3) as a life insurance beneficiary; 4) as a survivor under an annuity contract; 5) as a donee/possessor of a general power of appointment (GPOA); 6) as appointee under an exercised GPOA; or 7) as a remainder beneficiary under a release or lapse of a power of appointment by reason of which the property is included in the gross estate of the donee of the power under [section]2041. Treas. Reg. [section]20.2013-5(a) defines property as "any beneficial interest in property, including a [GPOA]...." (4) These broad regulatory definitions of "transfer" and "property," which do not require the transferred property to be included in the transferee spouse's gross estate or even exist when the transferee spouse dies, are what allow significant FET savings to be generated in the transferee spouse's estate.

The TPT credit is restricted in two significant ways. First, the TPT credit is limited to the lesser of 1) the amount of FET attributable to the transferred property in the transferor spouse's estate (the first limitation) (5); and 2) the amount of FET attributable to the transferred property in the transferee spouse's estate (the second limitation) (the lesser of the first limitation and second limitation are referred to collectively hereafter as the "FET liability limitation"). (6) The first limitation is calculated by multiplying the transferor's net FET liability (7) by the value of the transferred property, (8) and then dividing that result by the transferor's net taxable estate. (9)

Unlike the first limitation, the second limitation is a theoretical calculation that, as alluded to in this article's introduction, does not require the transferred property to be traced into the transferee spouse's gross estate. Put simply, the second limitation is determined by subtracting the net FET liability on the transferee's estate, including the transferred property (the greater transferee FET liability) from the net FET liability on the transferee's estate, excluding the transferred property (the lesser transferee FET liability). In practice, this calculation is less than straightforward and contains multiple traps for the unwary.

The easiest part of the second limitation is determining the greater transferee FET liability, which is identical to a normal estate tax calculation except with the inclusion of the transferred property in the gross estate. When calculating the lesser transferee FET liability, "wrinkles" appear when the transferee's estate is entitled to charitable and, possibly, in the event of a remarriage, marital deductions. Treas. Reg. [section]20.2013-2(b) presumes that any charitable deduction in the transferee's estate is satisfied proportionally out of all estate assets, including the transferred property. There is no regulatory corollary for an augmented marital deduction in the transferee's estate (which can only occur if the transferee remarries); while no authority exists on this point, the same logic would seem to apply.

Section 2013(a) provides that if the transferee spouse dies within two years of the transferor spouse's death, the TPT credit is allowed at 100 percent of the FET liability limitation. If the transferee spouse dies more than two but within 10 years of the transferor spouse's death, the TPT credit is reduced incrementally based on when, in the above timeframe, the transferee spouse dies (the time limitation). If the first death occurs more than two, but within four years before the second death, the amount allowed by the FET liability limitation is reduced to 80 percent; if the second death occurs more than four, but within six years before the first death, the time limitation becomes 60 percent; if the second death occurs more than six, but within eight years before the first death, the time limitation becomes 40 percent; and if the second death occurs more than eight, but within 10 years before the first death, the time limitation becomes 20 percent. If the transferee spouse survives the transferor spouse by more than 10 years, the TPT credit is entirely disallowed by virtue of the time limitation.

The typical estate plan for married couples who wish to benefit each other consists of the creation of a bypass or "credit shelter" trust (CST) that utilizes the transferor spouse's applicable exclusion amount under [section]2010 (AEA), with the balance of assets passing into one or two mandatory income trusts for the surviving spouse that is/are entitled to qualify for the federal estate tax marital deduction under [section]2056(b)(7) as "qualified terminal interest property" (QTIP). (10) Under these plans, the FET liability limitation practically requires the decision to utilize the TPT credit (or not) to be made prior...