By Richard S. Franklin, Esq.
McArthur Franklin, PLLC, Washington, D.C.
Portability is among the estate tax provisions that sunset at year end. In the event you represent a surviving spouse having deceased spousal unused exclusion (DSUE), you may be wondering what is to become of the DSUE on January 1, 2013.1
One possibility is that Congress will make portability a permanent feature of the estate tax law. After all, the government already has a substantial investment in portability. Portability had been under study for many years before it was made part of the Tax Relief, Unemployment Reauthorization, and Job Creation Act of 2010.2 New temporary and proposed regulations have been issued3 and, most recently, a new draft estate tax form has been prepared to accommodate portability. Portability is also viewed favorably as a tax benefit for the middle class.
Even if portability is not made permanent, another possibility is that Congress will grandfather existing elections. That would create some degree of fairness for those relying on DSUE elections as currently allowed.
It is important that your clients understand, however, that they do not have to wait for the outcome of this legislative uncertainty. The current rules allow any surviving spouse having DSUE from a deceased spouse since January 1, 2011, to use the DSUE by gift, before January 1, 2013.
A common misconception is that both spouses must die before January 1, 2013, to benefit from portability. This is simply not true. If one spouse dies on or after January 1, 2011 and before January 1, 2013, the surviving spouse may immediately use the DSUE by making gifts. Therefore, you should add "use any DSUE in 2012" to your growing checklist of action to take before the end of 2012.
In considering this year end planning idea, two provisions of the temporary and proposed regulations favorably affect the use of DSUE by gift. A new ordering rule addresses the use of the DSUE when the surviving spouse makes a gift. Regs. §25.2505-2T(b) provides that, when a surviving spouse makes a taxable gift, such spouse first uses the DSUE of the person who was the "last deceased spouse"4 at the time of the gift, before the surviving spouse is required to use his or her own basic exclusion amount.
The new temporary and proposed regulations also eliminate the concern about recapture. Absent the new regulations, if the surviving spouse remarried, it would be possible that the surviving spouse's DSUE from such spouse's first deceased spouse could disappear if the new spouse dies before the surviving spouse, thus causing portability recapture. The new regulations eliminate this possibility by providing that, if the surviving spouse had multiple spouses and made taxable gifts relying on a predeceased spouse's DSUE, the surviving spouse could use that DSUE. This would be the case even if the DSUE is from the person who would not qualify as the "last deceased spouse" at the time of the surviving spouse's death.5
Essentially, the surviving spouse's applicable exclusion amount upon death includes both (i) the DSUE amount of the "last deceased spouse," and (ii) if the surviving spouse made taxable gifts, an amount equal to the DSUE amount from a prior spouse who was, at the time of such taxable gifts, the "last deceased spouse" applicable to such taxable gifts.
For more information, in the Tax Management Portfolios, see Streng, 800 T.M., Estate Planning, and Pennell, 843 T.M., Estate Tax Marital Deduction, and in Tax Practice Series, see ¶6350, Estate Planning, and ¶6270, The Marital Deduction - Section 2056.
1 Of course, for a surviving spouse to have any DSUE, his or her deceased spouse must have died on or after Jan. 1, 2011, and the portability election must have been made on the deceased spouse's timely filed estate tax return (including extensions). For more detail on using the DSUE by gift, see Franklin & Law, "Portability's Role in the Evolution Away from Traditional By-Pass Trusts to Grantor Trusts," 37 Tax Mgmt. Est., Gifts & Tr. J. 135 (Mar./Apr. 2012).
2 P.L. 111-312.
3 T.D. 9593, 77 Fed. Reg. 36150 (6/18/12) (temporary regulations); REG-141832-11, 77 Fed. Reg. 36229 (6/18/12) (proposed regulations with same text as temporary regulations).
4 See Regs. §§25.2505-2T(a), 20.2010-1T(d)(5).
5 Regs. §§25.2505-2T(c) (with respect to gift taxes), 20.2010-3T(b) (with respect to estate taxes).