New IRS ruling where surviving spouse forgot to timely file the deceased spouse’s federal estate tax return and thereby failed to make portability election

When one spouse dies on or after January 1, 2011, his or her federal estate tax exemption can be transferred to the surviving spouse if the surviving spouse files a timely form 706 federal estate tax return for the first-spouse-to-die. Under certain conditions, based on Rev Rul 2014-18 which the IRS issued on January 27, 2014, a late-filed 706 will be considered as if it were timely filed, ie it will be treated as effective for purposes of making the portability election. Those conditions are:

1. The first-spouse-to-die was a U.S. citizen or resident
2. The first-spouse-to-die died in 2011, 2012 or 2013
3. A form 706 was not previously filed for the first-spouse-to-die
4. A form 706 was not required to be filed for the first-spouse-to-die because the estate of the first-spouse-to-die was not large enough to require it being filed.
5. The form 706 for the first-spouse-to-die must be filed no later than December 31, 2014
6. The form 706 for the first-spouse-to-die must state at the top of page one: Filed Pursuant to Revenue Procedure 2014-18 to elect portability under Section 2010(c)(5)(A)
7. The filer of form 706 is the executor of the estate of the first-spouse to die.

If you are a surviving spouse, or if you know of a surviving spouse who finds himself or herself in this position, it is critical that this opportunity be taken advantage of. Stated differently, if the above conditions all exist, the surviving spouse needs to file the first-spouse-to-die’s estate tax return form 706 no later than December 31, 2014 with the required statement on the top of page one in order to transfer the first-spouse-to-die’s estate tax exemption to the surviving spouse.

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Is there a need to save estate tax?

For persons dying in 2014, the estate tax exemption is $5,340,000. If the surviving spouse files a timely estate tax return for the first-spouse-to-die, the first-spouse-to-die’s exemption can be added to the surviving spouse’s exemption. This is called portability. Unless the current exemptions are reduced, and there is no longer a sunset date at which they will expire, the assets of most people will not be subject to the federal estate tax at their deaths. President Obama has put forward a proposal which would reduce the exemption to $3,500,000, but at this time there are not enough favorable votes in Congress to pass this proposed legislation. It is important for people to monitor future changes in the law that Congress might choose to enact.

In 2014 the annual free gift is $14,000 per donor per donee. Many people make gifts to family members either out of love or to help meet a need of the donee. But if the only reason for making the gift is to save estate taxes, donors need to consider whether or not their assets are likely to be subject to estate taxes based on the current rules discussed above.  Further, there are advanced techniques to reduce estate taxes such as family limited partnerships, grantor retained annuity trusts, sales to defective grantor trusts, and qualified personal residence trusts. In determining whether or not these advanced techniques are worth considering, donors again need to consider whether or not their assets are likely to be subject to estate taxes.  

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Assets Located Outside of the United States

Sam and Jill have created a revocable living trust. They have been told to transfer their assets into their trust in order to avoid probate. When their attorney asked them to list their assets, they forgot to tell him about assets they own in one or more foreign countries.

Most foreign countries do not allow living trusts. Sam and Jill have pour-over Wills which say that all assets they forgot to transfer into their trust while they were living will go to their trust when they die. When Sam dies, Jill sends a copy of his Will to an attorney in France in order to get his real property located there re-titled into the name of the trust. Only then is Jill told that the Will is going to cause trouble and confusion in France because they don’t allow trusts.

If Sam and Jill had told their attorney about their foreign assets, their attorney could have advised them to hire an attorney in each foreign country in which they own assets and to direct that attorney to prepare a Will disposing of their assets in that specific country. In this way, each foreign Will can comply with the laws of that country and be valid and effective. 

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State Inheritance Tax


California no longer has a State Inheritance Tax. The Federal Estate Tax Exemption in 2013 is  $5,250,000. This does not mean that a person dying with an estate that is less than  $5,250,000 will not be subject to a State Inheritance Tax.

California residents may die owning assets in other states. Those other states may or may not have their own inheritance tax. If they do, those states may have exemptions that are lower than $5,250,000.

Some other states that still have an inheritance tax compute their tax based on the deceased person’s assets located both inside and outside of that state and then allocate the tax by multiplying the total by the fraction of the assets that are located in their state. 

For example, assume that State X allowed an exemption of  $3,500,000 and had an inheritance tax of 30% on the excess. A California resident died with $3,000,000 worth of assets located in California and $1,000,000 worth of assets located in State X. In step one of the computation State X’s 30% tax rate is multiplied by ($4,000,000 value of all assets  minus $3,500,000 State X exemption) totaling $150,000. The State X inheritance tax would then be 25% multiplied by $150,000 totaling  $37,500.   

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Re-Evaluating your Successor Trustee

Odysseus, the legendary Greek King of Ithica and the hero of Homer’s epic poem the Odyssey, spent years away from his kingdom fighting in  the Trojan Wars. During that time, his wife had to remain faithful to him and she had to use her wits to resist many potential suitors.

Like Odysseus’ wife, your successor trustee will at your death, resignation or incapacity be given the challenge of being faithful to your estate plan and to the beneficiaries it is meant to protect. You should periodically review the people you have designated in your trust as successor trustees. You should then ask yourself whether the people currently named to act are still the best choices, or whether other people would be better suited for this role. If changes need to be made, you need to see to it that your trust is amended as soon as possible.

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Estate Tax Changes 2013.

The estate tax exemption was about to go down to $1,000,000 starting January 1, 2013, but the 2012 Tax Relief Act permanently extended the $5,000,000 gift and estate tax exemption. That exemption is projected to be $5,250,000 for 2013, and through indexing it will go up in the future. The estate and gift tax rate is 40% (a compromise between the 45% rate that the Congressional Democrats wanted and the 35% rate that the Congressional Republicans wanted)

Portability, the ability of the surviving spouse to file a timely estate tax return for the first-spouse-to-die and to thereby add that spouse’s exemption to the surviving spouse’s own exemption, has been made permanent.

Unless and until new legislation is enacted, taxpayers no longer need to worry about the estate tax exemption going down or the portability legislation going away.

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Estate Tax Uncertainty

As of December 12, 2012 as I write this newsletter, Americans do not know what will happen to the estate tax law on January 1, 2013. Yes, we know that the exemption for gifts during life, or for gifts at death, or any combination of the two is $5,120,000 for 2012. Yes, we know that the exemption is scheduled to go down to $1,000,000 in 2013. Yes, we know that neither the Democrats nor the Republicans want the exemption to go down to $1,000,000.

How did we get here? When the exemption became $1,000,000 in 2001 (not 2011) there was a sunset provision that said that because the budget didn’t balance, the law would expire. It was scheduled to expire January 1, 2011. But on December 17, 2010, President Obama and the Republicans made a deal to increase it to $5,000,000 for 2011($5,120,000 for 2012).

But because the Republicans wished to continue to work to abolish the estate tax, this ‘deal’ was a two year deal, expiring January 1, 2013. Thus the rule that the law would go back to the $1,000,000 exemption of 2001 was extended two more years.

Some people are considering making large gifts before January 1, 2013 in the hope that these gifts will be grandfathered, ie in the hope that if the exemption is less in the year the donor dies, the donor will qualify for the higher exemption because of the large lifetime gift. It is not clear whether or not grandfathering will be allowed because of the possibility of ‘clawback’ meaning that gifts during life will be added back into the estate tax return but the exemption might be restored only up to the date of death exemption amount.

Many commentators believe there will be grandfathering rather than clawback, but even if there is grandfathering, this strategy will only work if the exemption goes down, ie if the exemption stays at $5,120,000, there will be no grandfathering.

Also, if gifts of appreciated assets are made during life, the step-up in basis that occurs (for income tax purposes) when a person owns assets at the time of his or her death will have been lost and this negative result  has to be weighed against possible estate tax benefits.

Finally, to have the lifetime gift recognized as a completed gift for estate tax purposes, the donor must be prepared not to get any benefits from the assets given away during life, for example the donor should not try to have his or her children pay his or her expenses from the gifted property.

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