Recent developments in estate planning.

• Author: Ransome, Justin P.
• Position: Part 2

This is the second in a two-part article examining developments in estate, gift, and generation-skipping transfer (GST) tax and compliance between June 2012 and May 2013. Part I, in the September issue, discussed gift tax and trust developments, the extension of a number of expiring favorable estate and gift tax provisions by the American Taxpayer Relief Act of 2012, the taxation of trusts subject to the new 3.8% net investment income tax, and inflation adjustments for 2013. This part covers developments in estate tax and GST tax.

Estate Tax

Portability Regulations

One of the provisions in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (1) amended Sec. 2010 to allow for portability of the estate tax exemption between spouses. Sec. 2010(c) generally allows the surviving spouse of a decedent dying after Dec. 31, 2010, to use the decedent's unused estate tax exemption in addition to the surviving spouse's own estate tax exemption.

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For example, if a decedent died in 2011 (when the estate tax exclusion amount was $5 million) with a taxable estate of $3 million, the decedent's estate could make the portability election so the decedent's surviving spouse would have an exclusion amount of $2 million from the decedent in addition to his or her own exclusion amount. Thus, the election eliminates the need for spouses to retitle property and create trusts solely to take full advantage of each spouse's estate tax exemption. The portability provision was made permanent by the American Taxpayer Relief Act of 2012.(2)

On June 18, 2012, temporary(3) and proposed(4) regulations were issued to provide guidance on the portability of the deceased spousal unused exclusion (DSUE) amount, including how to make the portability election and how a surviving spouse uses the DSUE amount. The portability election must be made by timely filing an estate tax return, Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, which is due nine months after the date of the decedent's death unless an extension of time to file is obtained. The regulations clarify that, to make the portability election, the estate tax return must be filed within this time period even if the estate would not otherwise be required to file a return (because the decedent's gross estate is less than $5.25 million for 2013).

If the executor chooses not to make the portability election, the executor must check the box in Section A of Part 6 of Form 706 to opt out of the portability election. If no estate tax return is required to be filed, taxpayers avoid making the election by not filing a timely return. Once made, the election is irrevocable.

The executor is the one who must make the election. If there is no appointed executor, any person in actual or constructive possession of any of the decedent's property (a nonappointed executor) may file the estate tax return and make the election. A portability election made by a nonappointed executor cannot be superseded by a contrary election made by another nonappointed executor.

To make the election, the estate tax return must be complete and properly prepared. The temporary regulations provide that if the estate is not otherwise required to file an estate tax return, the estate tax return does not have to report the value of certain property that qualifies for the marital or charitable deduction. In such a situation, the executor will be required to report only the description, ownership, and/or beneficiary of that property along with the information necessary to establish the estate's right to the marital or charitable deduction for that property.

If the executor chooses this filing option, the executor must estimate the total value of the gross estate, based on a determination made in good faith and with due diligence of the value of all the assets includible in the gross estate. The executor must identify the particular range applicable to the gross estate using the ranges of dollar values that are provided in the Form 706 instructions.

The executor must compute the DSUE amount in Section C of Part 6 of Form 706, using, the basic exclusion amount in effect in the year of the death of the decedent whose DSUE amount is being calculated. If the decedent paid gift tax on taxable gifts because these gifts exceeded the applicable exclusion amount at the time of the gift, the gifts are excluded from adjusted taxable gifts for purposes of computing the decedent's DSUE amount. This adjustment is necessary so that the decedent's exclusion amount is not used for amounts on which gift tax was paid. The temporary regulations do not address how the DSUE amount is affected by other available estate tax credits (i.e., Sec. 2013 credit for tax on prior transfers, Sec. 2014 credit for foreign death taxes, and Sec. 2015 credit for death taxes on remainder), instead requesting comments before regulations are issued on the issue.

If the portability election is made, the surviving spouse can use the DSUE amount for transfers occurring after the decedent's date of death. The temporary regulations also address who is the "last deceased spouse" of the surviving spouse. The last deceased spouse is the most recently deceased individual who was married to the surviving spouse at that individual's death, provided the individual died after Dec. 31, 2010. The surviving spouse's remarriage does not affect who will be considered the last deceased spouse and does not prevent the surviving spouse from including in the surviving spouse's applicable exclusion amount the DSUE amount of the deceased spouse who most recently preceded the surviving spouse in death.

The identity of the last deceased spouse is not affected by whether the estate of the last deceased spouse makes the portability election or has any DSUE amount available. When a surviving spouse has more than one deceased spouse, the temporary regulations apply an ordering rule. Any gifts a surviving spouse makes use up the DSUE amount of the last deceased spouse (identified as of the date of the gift) before using up any of the surviving spouse's own basic exclusion amount. The surviving spouse's DSUE amount then becomes the DSUE amount of the last deceased spouse (identified as of the date of a subsequent gift or the death of the surviving spouse) plus any DSUE amount actually applied to the surviving spouse's taxable gifts to the extent it was from a decedent who is no longer the last deceased spouse. Examples in the temporary regulations illustrate how these provisions work.

The temporary regulations confirm that the IRS may, at any time, examine the returns of each deceased spouse of the surviving spouse to adjust or eliminate the DSUE amount, but may assess additional estate tax on those prior returns only if the period of limitation on assessments under Sec. 6501 is still open.

The temporary regulations also address the application of the portability rules when the decedent's assets are transferred to a qualified domestic trust (QDOT) for the benefit of a surviving spouse who is not a U.S. citizen. Under Sec. 2056A, the decedent's estate tax is ultimately imposed when taxable distributions are made from the QDOT. The tax generally equals the amount of additional estate tax that would have been imposed if the amount of the taxable distribution had been taxable in the decedent's estate (and not deductible as part of the marital deduction). The amount of estate tax that would have been imposed is computed by determining the net tax after the allowance of any credits, including the applicable credit amount.

Because portability is available to a surviving spouse only to the extent the decedent's exclusion amount is not used by the decedent's estate, the temporary regulations provide that the decedent's applicable exclusion amount is available to the decedent's estate until the decedent's final estate tax liability is computed. Consequently, the executor will compute a DSUE amount on a preliminary basis on the decedent's estate tax return for purposes of electing portability, and this amount will subsequently be redetermined on the final distribution from the QDOT or other taxable event on which the estate tax under Sec. 2056A is imposed (e.g., death of the surviving spouse). The DSUE amount, if any is left, will be available for transfers occurring by reason of the surviving spouse's death and will be available in only limited circumstances for gifts during the surviving spouse's life.

Valuation of Art Interests

In Estate of Elkins, (5) the Tax Court held that a 10% fractional interest discount in artwork applied to the decedent's fractional ownership interest in art, dismissing the IRS's long-held position that no discounts should be allowed for fractional interests in art. The decedent and his wife, who together purchased 64 works of art, each created a grantor retained income trust (GRIT) funded by each spouse's undivided 50% interest in three of the works of art (the transfers occurred before Sec. 2702 applied...