Sect. 2033: Property In Which The Decedent Had An Interest • Decedent’s beneficial interest in property • Beneficial interest in life insurance on others’ lives is included. 20
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Sect. 2035: Adjustments For Certain Gifts Made Within Three Years Of Death • 2035(a): Interest transferred by the decedent that, if it had been retained by the decedent as of his/her death, would have been includible in the decedent’s gross estate under sections 2036, 2037, 2038 or 2042. Sect. 2035(a)(2) – Excluded: Bona fide sale for an adequate and full consideration in money or money's worth 22
Sect. 2035: Adjustments Fr Certain Gifts Made Within Three Years Of Death (Cont.) • 2035(b): Requires the federal gift tax paid by the decedent or the decedent's estate on any transfers made after 1976 by the decedent or the decedent’s spouse within three years of the decedent’s death to be included in the decedent’s gross estate. 23
Sect. 2036: Transfers With Retained Interests • 2036(a)(1): Decedent retains “the possession or enjoyment of” or “the right to the income from” the transferred property or property interest. • Excluded: Bona fide sale for an adequate and full consideration in money or money's worth 24
Sect. 2036: Transfers With Retained Interests (Cont.) • 2036(a)(2): Decedent retains the right for life (or for any similarly prescribed period) to say who may enjoy transferred property or the income therefrom, even if the decedent has put it beyond the power to claim enjoyment or income for the decedent’s own benefit. 25
Sect. 2036: Transfers With Retained Interests (Cont.) • 2036(b): Decedent directly or indirectly retains voting rights in a “controlled corporation”; deemed a retention of the “enjoyment” of transferred property so as to trigger Sect. 2036(a)(1). – “Controlled corporation” is defined as a corporation in which the decedent owns, directly or by attribution under Sect. 318, stock possessing at least 20% of the combined voting power of all classes of stock of the corporation; or if the decedent has a right to vote (either alone or in conjunction with any other person) at least 20% percent of the combined voting power. 26
Sect. 2036: Transfers With Retained Interests (Cont.) • Transfer can be made directly by the decedent, or indirectly as in a deemed transfer under the reciprocal trust doctrine. • Amount includible in gross estate is the value of the transferred property upon death (not the value of the retained interest). 27
Sect. 2037: Transfers Taking Effect At Death • Sect. 2037 includes property in a decedent’s taxable estate if the decedent has made a transfer of the property to take effect only at or after the decedent’s death, and has retained a reversionary interest in such property (perhaps expressly) that has a value just before the decedent’s death in excess of 5% of the value of the property transferred. • Excluded: Bona fide sale for an adequate and full consideration in money or money's worth 28
Sect. 2038: Revocable Transfers • Sect. 2038 applies to include the value of an interest in property when the decedent has transferred such property, but “enjoyment thereof was subject at the date of his death to any change through the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired such power), to alter, amend, revoke, or terminate, or where any such power is relinquished during the 3-year period ending on the date of the decedent’s death.” – Excluded: Bona fide sale for an adequate and full consideration in money or money’s worth 29
Sect: 2038: Revocable Transfers (Cont.) • Unlike Sect. 2036, which taxes the entire property transferred by the decedent, Sect. 2038 only taxes the value of the interest over which the decedent maintains the power to alter, amend, revoke, terminate, etc. … 30
Sect. 2039: Annuities (With Survivorship Proceeds) • Sect. 2039 generally includes the value of annuities that are payable to the decedent during lifetime and continue after the death of the decedent, or that provide for proceeds to be paid to beneficiaries. – Excluded: Life insurance contracts (covered by Sect. 2042) 31
Sect. 2039: Annuities (With Survivorship Proceeds), Cont. • Sect. 2039(b) restricts the inclusion of an annuity in a decedent’s estate to the proportionate value of the annuity paid for by the decedent. 32
Sect. 2040: Joint Interests • Sect. 2040(b): As to spousal joint property interests (with right of survivorship) created after 1977, Sect. 2040 includes one-half (1/2) of the value of such property in the decedent’s estate. – Inapplicable when the surviving spouse is not a U.S. citizen 33
Sect. 2040: Joint Interests (Cont.) • Sect. 2040(a): Other joint property is fully includible in the decedent’s taxable estate, except to the extent that the surviving tenant or tenants contributed to the cost of the acquisition of the property. 34
Sect. 2041: Power Of Appointment • Sect. 2041 includes property over which the decedent holds a general power of appointment. • Excluded: 1. Powers subject to ascertainable standards 2. Pre-1942 powers 3. Powers held with adverse party or creator 35
Sect. 2042: Proceeds Of Life Insurance • Sect. 2042 includes life insurance proceeds in the decedent’s taxable estate if: Proceeds are receivable by the decedent’s executor, or 1. 2. Proceeds are receivable by other beneficiaries and the decedent has any incidents of ownership in the policy at death. 36
Sect. 2043: Transfers For Insufficient Consideration • Sect. 2043(a) applies to a transfer under sections 2035, 2036, 2037, 2038 or 2041 for some consideration; but not a bona fide sale for adequate and full consideration. – Includible amount is “the excess of the fair market value at the time of death of the property otherwise to be included on account of such transaction, over the value of the consideration received therefor by the decedent.” 37
Sect. 2043: Transfers For Insufficient Consideration (Cont.) • 2043(b) states that the relinquishment of marital rights is generally not consideration. 38
Yahne Miorini, Miorini Law DEDUCTIONS AND CREDITS
Introduction There are five parts to Form 706, nine schedules to determine the gross estate and seven schedules to determine the applicable deductions. Schedules A through I are used to determine the gross estate. Schedules J through O plus Schedule U are used to determine applicable deductions. Schedules P and Q are used to determine applicable tax credits. It is good practice to include all of the schedules and mark “ 0 ” on those schedules that do not show any assets, exclusions or deductions. 40
Schedule J Schedule J – Funeral and administrative expenses • ― Funeral: Allowable "reasonable expenses" ― Tombstone, burial lot, cost of body transportation ― “Reasonable expenses” based on the decedent’s wealth and standard of living ― Administrative expenses can be allocated as the fiduciary’s discretion between Form 706 and the estate’s income tax return. ― No double deductions allowed ― Interest: Federal estate tax deficiency interest is includable ― Executor’s commission, attorney and accountant fees closely monitored by IRS ― Actually paid or reasonable expected to be paid ― Do not include attorney fees incidental to litigation incurred by a beneficary 41
Schedule K Schedule K – Debts, mortgages and liens • ― Part 1: Decedent’s debts, tax liabilities, obligations to spouse at time of death ― In case of difficulty, a computation can be requested to the IRS. ― Part 2: Mortgage for which the decedent is liable and contingent liabilities 42
Schedule L Schedule L – Net losses during administration and expenses • incurred in administering property not subject to claims ― Casualty losses incurred during the settlement of the estate ― Theft, fire, storm, shipwreck 43
Schedule M: Unlimited Marital Deduction The Economic Recovery Tax Act (ERTA) of 1976 has created an unlimited • marital deduction. The assets bequeathed to the spouse are treated as deductions and are reported under Schedule M of the federal estate tax return. One of the objectives of the act was to correct the discrepancy in tax • treatment between the community states and the non-community state. • Community states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. • A homemaker surviving spouse in a community state would always keep half of the assets of the community, and it’s only the other half of the community assets that would be reported in the decedent gross estate. ERTA was to help unify the IRS treatment of husband and wife. The IRS • already treated the husband and wife as “one economic unit,” for income tax purposes. ERTA expanded this concept for estate and gift taxes. 44
Schedule M (Cont.) Schedule M – Unlimited marital deduction • ― Property interests passing to a surviving U.S. citizen spouse may qualify for the marital deduction under IRC Sect. 2056. ― A QTIP election can be made either for the entire value of the trust or for a portion of it. ― The portion not reported on Schedule M should be included in the gross estate. ― Deduction available to non-U.S. citizens through a QDT (qualified domestic trust) ― Funding of marital deduction should be carefully reviewed (audits). 45
Schedule M (Cont.) Property interests that you may not list on Schedule M • ― The full value of a property interest that passes to the surviving spouse subject of a mortgage, or other encumbrance or an obligation of the surviving spouse ― Non-deductible terminable interest: Interest that will terminate or fail after the passage of time, or on the occurrence or nonoccurrence of a designated event. IRS e.g.: file estate, annuities, estate for terms of years, and patents ― Any property interest disclaimed by the surviving spouse 46
Schedule M (Cont.) IRS example of description: • One-half the value of a house and lot, 256 South West Street, held by decedent and surviving spouse as joint tenants with right of survivorship under deed dated July 15, 1975 (Schedule E. Part I. item 1) … Proceeds of Metropolitan Life insurance Company policy No. xxx, payable in one sum to surviving spouse (Schedule D. item 3) … Cash bequest under Paragraph Six of Will … 47
Schedule M: QTIP Election Election needs to be made by the executor. • Election can be partial. If in a trust, you need a defined • fraction or percentage of the entire trust. The fraction or percentage may be defined by means of a formula. The election is irrevocable. If you don’t make the election in • your filed Form 706, you cannot file an amended return to make the election unless the amended return is filed on or before the due date for filing the original Form 706. • Election makes the property/interest as passing to the surviving spouse as deductible interest. Presumption that you made the election when the • property/interest is listed on Schedule M. 48
Schedule M: QTIP Election (Cont.) Requirement of IRC Sect. 2056(b)(7) • ― Surviving spouse is entitled to all of the income from the property, payable annually or at more frequent intervals. ― During the life of the surviving spouse, nobody has a power to appoint any part of the property to any person other than the surviving spouse. 49
Schedule O Schedule O – Charitable deductions • ― All interests qualifying for charitable deductions under IRC Sect. 2066: ― Outright transfers to charitable organizations ― Qualified split interest charitable remainder trusts ― Property passing to charities by court decree ― Qualified conservation easements ― Outstanding charity pledge, if enforceable, is reported on Schedule K, not on Schedule O. ― No limit on the amount of charitable deductions 50
Schedule U Schedule U – Qualified conservation easement exclusion • ― Maximum amount: $500,000 ― Enable fiduciary to exclude a portion of the value of the land subject to a qualified conservation easement ― Criteria to be met: ― Three-year ownership ending on the date of decedent’s death ― No later than the date of the election, a QCE has been made. ― The land is situated in the U.S. or one of its possessions. ― Conservation purposes are: ― Preservation of land for outdoor recreation, education or the public ― Protection of a relatively natural habitat/ecosystem ― Preservation of open space for scenic enjoyment or yielding significant public benefit as determined by the government 51
Schedule P: Credits Schedule P – Credit for foreign death tax • ― Applicable if decedent owned property overseas ― If the decedent is a non-resident U.S. citizen, the following documents are required: ― Copy of property inventory ― Including schedule of liabilities claims against the estate ― Copy of the return filed under the foreign inheritance, estate legacy, succession tax or other death tax act 52
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Schedule Q Schedule Q – Credit for tax on prior transfers • ― Applicable when transferee receives property from a transferor who died within the previous 10 years or died two years after the transferee ― Property: Any interest which the transferee received the beneficial ownership ― A credit may be allowed for property received as the result of the exercise or non-exercise of a power of appointment, when the property is included in the gross estate of the donee of the power 54
Schedule Q (Cont.) Spouses don’t qualify unless the spouse was not a citizen of • the property passed outright to the spouse or to a qualified domestic trust. 55
Schedule Q (Cont.) Period Of Time Not Exceeding Percent Allowable Exceeding ……. 2 years 100 2 years 4 years 80 4 years 6 years 60 6 years 8 years 40 8 years 10 years 20 10 years ….. None 56
Schedules R And R-1 Generation-skipping transfer tax history: • The first generation-skipping transfer tax was enacted by the 1976 Act. This tax was created in order to prevent the avoidance of transfer taxes over a period of successive generation. The tax was tremendously complex. The 1986 act repealed it and replaced with a new transfer tax applicable to all generation- skipping transfers whether by way of a trust, trust equivalent, or direct transfer. The generation-skipping transfer (GST) tax applied to estate tax and gift tax. This tax was created for people dying after Oct. 22, 1986. The tax is imposed only on the value of the interests in property that actually pass to certain transferees, who are referred as “skip persons. ” 57
GST: Generation-Skipping Transfers The GST tax brings new concepts such as “transferor” and “generation . ” Under IRC Sect. 2652(a), the transferor is the donor or the decedent. The generation is defined among the family lines. There is the generation of the transferor, which includes the transferor, the transferor’s spouse and the transferor’s siblings. The children are part of the next generation; the grandchildren are part of the generation following. If the transfer is made outside the family, generations are determined by ages. A person who was born not more than 12½ years after the decedent is in the same generation of the decedent. A person born more than 12½ years, but not more than 37½ years, after the decedent is in the first generation younger than the decedent. A similar rule applies for a new generation every 25 years. Therefore, a skip person is a natural person who was born more than 37 ½ years after the decedent. 58
GST Skipping Transfers (Cont.) There are three types of generation-skipping transfers: • ― taxable terminations, ― taxable distributions, and ― direct skips. 59
GST Skipping Transfers (Cont.) A taxable termination occurs upon the termination of an interest in • a trust. After the termination event, the skip person holds all interest in the trusts. For instance, dad created a trust, giving the income for life of his daughter and the remainder to his granddaughter. A taxable distribution exists when there is a distribution of principal • or income from the trust to a skip person. For instance, mom created a trust providing payment of income and principal to her children and grandchildren. What is collected by the grandchildren is subject to GST tax. • A direct skip is when property is transferred without compensation to a skip person. Among family members, a skip person would be a grandchild. For a non-family member, a skip person is a person of two or more generations below the transferor. 60
GST (Cont.) A married couple may elect to treat generation-skipping • transfers as being made one-half by each spouse. The QTIP election used for estate tax purpose is separate and ignored for GST tax. The fiduciary may allocate part or all of the decedent’s GST exemption to the property. Because each person is entitled to a GST exemption, indexed for inflation, the GST election on a QTIP trust allows using two times the GST exemption. This is a reverse QTIP election. See IRC Sect. 2652(a)(3) 61
GST: Tax Allocation The amount of tax imposed on any generation-skipping • transfer is determined by multiplying the “taxable amount” by the “applicable rate. ” See IRC 2602 • 62
GST: Taxable Amount The taxable amount varies depending on the transfer. • • For a taxable distribution transfer, the taxable amount is the transfer received by the transferee, reduced by the expenses incurred in the determination, collection or refund that Chap. 13 tax imposed. • For a taxable termination transfer, the taxable amount is the value of property received at the termination reduced by deductions similar to Sect. 2053. For a direct skip transfer, the taxable amount is the amount • received. The taxable distribution transfer and the taxable termination transfer are tax-inclusive transfers, while the direct skip transfer is a tax-exclusive transfer. In a tax-inclusive transfer, the tax is calculated on the amount of the transfer. 63
GST: Applicable Tax Rate The applicable rate of tax is defined as the maximum transfer • tax rate then in effect, multiplied by the inclusion ratio. • See IRS 264(1a) 64
Inclusion Of Prior Gift Tax On Line 4 of IRS Form 706, you need to lists the cumulative • amount of adjusted taxable gifts (IRC Sect. 2503). The computation of gift tax payable uses the IRC Sect. 2001(c) rate schedule in effect as of the date of death , rather than the actual amount of gift taxes paid with respect to the gifts. ― PB: Top bracket tax rates decreased from 55 % (2001) to 35% (2010). There are situations in which the gift tax paid was greater than the tax calculated using the rate in effect at the date of death. ― IRS Web site warns about software used by practitioners that will require manual input of the gift tax payable line, and errors resulting in underpayment of estate tax due. 65
Jerome Deener, Fox Rothschild PORTABILITY ELECTIONS
Portability • What is portability? – The Sect. 2056 estate tax marital deduction allows spouses to deduct unlimited amounts for property that passes from a decedent to his or her surviving spouse. 67
Portability (Cont.) • Made permanent by ATRA, a surviving spouse is entitled to a total estate tax exemption (“applicable exclusion amount,” or “AEA”) consisting of two components: • The “basic exclusion amount” (BEA), currently $5.25 million, as indexed for inflation; and 68
Portability (Cont.) • The “eeceased wpouse’s unused exclusion amount” (DSUE), which is defined as: – The lesser of (a) the BEA and (b) the “Applicable Exclusion Amount” (AEA) of the surviving spouse’s last deceased spouse over the combined amount of the last deceased spouse’s taxable estate plus adjusted taxable gifts. Code § 2010(c)(4), as amended by ATRA, and Treas. Reg. § 20.2010-2T(c)(1)(ii)(A). 69
Portability (Cont.) • Example: – First spouse dies with $2 million, $1 million outright, to surviving spouse and $1 million in a credit shelter trust (CST). – First spouse has used $1 million of $5.25 million exemption, leaving $4.25 million unused exemption. – Surviving spouse dies with $9 million and the credit shelter trust of $1 million. • Surviving spouse’s estate pays no federal tax. 70
Portability (Cont.) Gross estate: $ 9M Less: BEA of surviving spouse (5.25M) unused exemption of first spouse (DSUE) (4.25M) Total 0 Plus: Credit shelter trust Not included 71
Portability (Cont.) • Variation: If first spouse has $5.25 million, and surviving spouse has $5.25 million, and first spouse leaves his $5.25 million to surviving spouse outright: – No estate tax in first estate and no exemption used – Surviving spouse has a taxable estate of $10.5 million but has her own $5.25 million BEA and a $5.25 million DSUE, so the surviving spouse’s estate pays no federal estate tax. 72
Portability (Cont.) – In all, a husband and wife together have $10.5 million of exemption. This is accomplished without shifting assets during spouses’ lives, without credit shelter trust and no matter which spouse predeceases the other. – Portability also applies for purposes of the lifetime gift exemption. The applicable credit for gift tax purposes under Sect. 2505(a) refers to the estate tax credit amount under Sect. 2010(c), “which would apply if the donor died as of the end of the calendar year.” The 2010(c) credit includes the DSUE, so the gift tax exemption also includes the DSUE. 73
Portability (Cont.) • Example, H-1 used $2,000,000 of exemption by leaving it in a credit shelter trust. Wife has $3,250,000 DSUE plus $5,250,000 basic exclusion amount. If she makes lifetime gifts of $3,250,000, do they come from DSUE or basic exclusion amount, or pro rata? – From the DSUE. Treas. Reg. § 25.2505-2T(b) – If W-1 remarries and she predeceases second spouse, she has her full exemption of $5,250,000 to give H-2. 74
Portability (Cont.) • In order to utilize portability, a specific election must be made on the federal estate tax return (Form 706) of the deceased spouse. Further, despite the running of the statute of limitation on the decedent’s estate tax return or gift tax return(s) with respect to the computation of the DSUE, the IRS may examine the returns of the deceased spouse to determine the amount of the DSUE for purposes of computing the surviving spouse’s applicable exclusion amount. See explanation of Treasury regulations later 75
Portability (Cont.) • Portability does not apply to the GST exemption. • However, this does not necessarily preclude the concurrent use of portability and both spouses’ GST exemptions. • In the case of a bequest to the surviving spouse in a trust that is eligible for the QTIP election, the executor can make both (i) the QTIP election (making the trust qualify for portability) and (ii) the Code Sect. 2652(a)(3) “reverse QTIP election” (permitting GST exemption of the deceased spouse to be allocated to the trust). 76
Portability (Cont.) • Upon the death of the surviving spouse, the surviving spouse will be able to apply his/her DSUE against the value of the QTIP trust, and the QTIP trust will be partially or fully exempt from generation- skipping transfer tax (depending upon whether the first deceased spouse’s GST exemption was sufficient to attain a zero GST inclusion ratio). • Election of portability can have adverse New Jersey and New York estate taxes in the estate of the first spouse to die. 77
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning • If the surviving spouse remarries, the DSUE can potentially disappear. • Reason: The DSUE is only available from the last deceased spouse. • If a surviving spouse remarries and then outlives the second spouse, the DSUE from the first deceased spouse is gone. 78
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning (Cont.) • Example: H1 dies with a taxable estate of $1 million, leaving a $4.25 million DSUE for W. W marries H2, who has a taxable estate of $5.25 million and leaves it all to H2’s children, thus using his entire $5.25 million exemption and leaving W with no DSUE. W’s $4.25 million DSUE from H1 is gone. 79
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning (Cont.) • Appreciation on property placed in a CST is excluded from the estate of the surviving spouse, but appreciation is not sheltered if instead assets pass outright and portability is relied upon. • Portability does not apply to the GST exemption. Therefore, in order to take advantage of the GST exemption of the first spouse to die, it is advantageous to continue to fund a CST. If a deceased spouse leaves everything to the surviving spouse outright, the family will lose $5.25 million of $10,500,000 potential GST exemption. 80
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning (Cont.) • Hard-to-value assets held in a CST (LLC, FLP or closely held stock) will not be subject to estate tax in survivor’s estate. However, if DSUE is elected, such hard-to-value assets can be subject to the IRS scrutiny in the estate of the surviving spouse. 81
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning (Cont.) • Portability does not apply to state estate taxes. – States like New York and New Jersey have decoupled from the Federal $5,250,000 exemption. New York: $1,000,000 exemption and New Jersey: $675,000 – Both states take the position that if a federal 706 is filed for any reason, and a QTIP election is made on the federal return, then the state QTIP election must be consistent with the federal QTIP election. – This has an impact if portability is considered. 82
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning (Cont.) – H and W are New Jersey residents. H has $3,250,000 and W has $3,250,000. H’s will provides that all of his estate passes to W, and H’s estate elects portability. – W gets $5,250,000 DSUE from H. – On W’s death, she has her own $5,250,000 exemption, plus DSUE from H to shelter her $6,500,000 from federal tax. No New Jersey tax is imposed in first spouse’s estate. No QTIP election is made, and nothing on New Jersey return is inconsistent with the federal return. 83
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning (Cont.) – On survivor’s death, the New Jersey tax on the $6,500,000 taxable estate = $574,000 (New Jersey will not recognize DSUE from first spouse’s estate). – In the alternative, if H’s assets consist of $3,250,000 in his name and instead pass into a CST, H’s DSUE is $2,000,000. Even though estate is under the $5,250,000 federal filing limit, H’s executor files a 706 to elect DSUE. No QTIP election is made on the federal 706, since QTIP is not necessary. New Jersey (and New York) positions are that QTIP for state purposes only may not be made, because that election is inconsistent with the federal return filed. herefore, on death of H, the estate owes state estate tax on a taxable estate of $3,250,000 = $205,200. 84
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning (Cont.) – If H’s estate did not elect DSUE, H’s estate would not file a federal 706, and New Jersey and New York positions are that his estate can make a state-only QTIP election to bring the state tax to zero. 85
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning (Cont.) – Executor’s conundrum: • Elect DSUE and pay $205,200 to protect $3,250,000 (plus appreciation) from future federal tax? • Or, don’t elect DSUE, forego state tax in H’s estate and hold onto $205,200, but without protection against federal estate tax on future appreciation 86
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning (Cont.) • Alternative: – Consider leaving an amount equal to the state exemption (for New Jersey, $675,000) in a credit shelter trust (thereby using the deceased spouse’s state exemption), with the remainder of the federal exemption amount (for New Jersey, $4,575,000 in 2013) in a “QTIP - able” trust for the surviving spouse’s benefit. The trust would provide all income is payable to surviving spouse for life, plus principal for surviving spouse’s needs of health, maintenance and support. No state estate tax upon the death of the first spouse, and the surviving spouse can elect QTIP and therefore take advantage of portability (in the case of New Jersey, the surviving spouse’s DSUE would be $4,575,000). 87
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning (Cont.) • The surviving spouse can then gift away his/her income interest in the QTIP trust, which is subject to the ascertainable standard, retaining his/her interest in the principal of the QTIP trust. Under Code Sect. 2519, this is considered a gift of the surviving spouse’s entire interest in the trust ($4,575,000, if no appreciation). Surviving spouse may apply his/her $4,575,000 DSUE against this $4,575,000 gift, making it tax-free and removing the QTIP trust assets from his/her New Jersey taxable estate. In all, no state estate tax will have been paid on the first deceased spouse’s $5,250,000. At the same time, the surviving spouse still has some access to the QTIP trust assets via his/her beneficial interest in the QTIP trust principal. 88
Tax And Non-Tax Reasons Not To Rely Upon Portability In Lieu Of Trust Planning (Cont.) • An outright disposition to the surviving spouse in lieu of a CST forgoes many non-tax benefits such as creditor protection, asset management, the ability for the deceased spouse to control the ultimate disposition of the assets upon the death of the surviving spouse, and the ability for the surviving spouse surviving spouse to control disposition if beneficial interests to family members during surviving spouse’s lifetime. 89
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Best Situations To Utilize Portability – Income Tax Benefits • Retirement assets – Prior to DSUE, if a married taxpayer had a large IRA but insufficient non-retirement assets to fully fund a CST, a decision had to be made as to whether: 91
Best Situations To Utilize Portability – Income Tax Benefits (Cont.) – To take advantage of: the income tax benefits of leaving an IRA to a surviving spouse (i.e., the spouse’s ability to roll the IRA into his/her own IRA using favorable required distribution rules, convert to a Roth IRA, etc. …), at the risk of potentially wasting estate tax exemption; or – To maximize the estate tax benefits of fully funding a credit shelter trust, but accelerate payout to the surviving spouse 92
Best Situations To Utilize Portability – Income Tax Benefits (Cont.) • Now, with portability, the taxpayer may name the spouse as the IRA beneficiary without wasting any of the deceased spouse’s estate tax exemption. The surviving spouse may take the IRA, roll it over, name new beneficiaries to get a longer stretch-out and/or convert to a Roth IRA, either all at once or over a number of years. » Example: Taxpayer has a $3 million IRA and $2 million of other assets. Taxpayer names spouse as the IRA beneficiary and leaves the rest of his assets in a CST. Upon death, spouse receives the $3 million IRA, $2 million is placed in the credit shelter trust, and taxpayer’s estate elects to transfer taxpayer’s unused exemption ($3.25 million) to spouse. 93
Best Situations To Utilize Portability – Income Tax Benefits (Cont.) • Note: While the $3.25 million estate tax exemption is not wasted, the income and growth of the IRA will not excluded from the spouse’s taxable estate. • Paying IRA proceeds to a CRT for New Jersey/New York exemption purposes may still be considered, in some cases. 94
Best Situations To Utilize Portability – Income Tax Benefits (Cont.) • Asset basis step-up – Assets passing pursuant to portability will receive an income tax basis step-up in the estate of the surviving spouse, whereas assets held in a CST would not be entitled to such a basis adjustment. – Now that income tax rates are increasing as expected, the income tax value of a basis step-up will increase relative to the transfer tax value of removing assets’ appreciation from the taxable estate of the surviving spouse. 95
Portability Regulations • On June 15, 2012, the Treasury Department issued temporary and proposed regulations aimed at resolving some of the issues left open by the portability statute. • Timely filed return 96
Portability Regulations (Cont.) • Code Sect. 2010(c)(5)(A) provides that the portability election must be made on the deceased spouse’s timely filed estate tax return, within the “time prescribed by law (including extensions) for filing such return.” – Under the regulations, the last return filed by the due date (including extensions) will supersede any previously filed return. Therefore, an executor can supersede a previously filed portability election. Once the due date has passed, the election is irrevocable. Treas. Reg. § 20.2010-2T(a)(4) 97
Portability Regulations (Cont.) – Issue : If an estate is under the federal threshold (and so technically is not required to file a federal 706), is the estate subject to the same election deadline as a taxable estate? Regs : Yes; Treas. Reg. § 20.2010-2T(a)(1) states that any – estate making the portability election is required to file a timely Form 706 under Code Sect. 6018(a). 98
Portability Regulations (Cont.) • “Complete” estate tax return – Notice 2011- 82 states that by filing a “properly prepared and complete” Form 706, an estate is considered to have made the portability election. – Issue : For an estate under the federal threshold, what is considered “properly - prepared and complete?” – Regs: 99
Portability Regulations (Cont.) Treas. Reg. § 20.2010-(a)(7)(i) provides that an estate tax return • prepared in accordance with all applicable requirements is considered complete and properly prepared. However, Treas. Reg. § 20.2010-(a)(7)(ii) provides a break for • smaller estates, stating that executors of estates that are not otherwise required to file an estate tax return do not have to report the value of certain property that qualifies for the marital or charitable deduction. 100
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