United States

Rev. Proc. 2016-49 gives a new lift to portability


Prior to 2010, portability was not part of the estate planning lexicon. But the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Act) introduced the concept, by allowing a surviving spouse to add to his or her own estate tax exemption, whatever amount of exemption his or her deceased spouse had not used during lifetime. This added exemption can be used during the survivor's lifetime for gifts or at death. The 2010 Tax Act made portability available with respect to spouses who passed away in 2011 or 2012. The American Taxpayer Relief Act of 2012 made portability permanent. When portability is available in a given estate, the deceased's estate will have to file an estate tax return to elect it.

At first blush, portability appeared to bring a welcome simplicity to estate tax planning for married individuals. That’s because prior to portability, the only way for one spouse to avoid wasting his or her estate tax exemption was to take a bifurcated approach to planning. In this approach, any exemption remaining at the death of the first spouse to die would fund a so-called ‘credit shelter’ or ‘bypass’ trust. This trust would typically benefit the survivor with income and distributions of principal under certain standards for his or her lifetime. Upon the survivor’s death, any remaining trust assets would be distributed to or remain in trust for the benefit of the children. From an estate tax standpoint, the real benefit of the trust is that any assets remaining in it when the survivor dies will not be included in his or her estate. However, those assets would not get a stepped-up basis at the survivor’s death.

The balance of the estate not passing to the credit shelter trust is left to the surviving spouse outright (or by beneficiary designation or joint tenancy) or in a general power of appointment or qualified terminable interest property (QTIP) trust that qualifies for the marital deduction.

With portability, the deceased’s exemption is preserved without the need for and expense of a credit shelter trust. Of course, there has been a lot of discussion about the circumstances in which portability might be more appropriate for a given couple than the credit shelter trust approach, or vice versa. But two of those discussion points come to mind now.

  • First, as noted, though whatever remains in the credit shelter trust will not be included in the survivor’s taxable, it will not get a stepped-up basis when it passes to the children. Assets that pass to the spouse directly (or in a marital deduction trust) will be included in the spouse’s estate but will get a stepped-up basis when he or she passes away. And with portability, the survivor can protect more of his or her estate with exemption from his or her deceased’s spouse.
  • The second point has less to do with taxes than it does control. Many individuals are not comfortable leaving property to their spouses in an outright fashion. Suffice it to say, these individuals may be concerned that something untoward and detrimental to the children could happen to those funds if left in the unfettered control of their surviving spouse. So, those individuals often turn to the QTIP trust that benefits the survivor with lifetime income and distributions of principal (only) at the trustee’s discretion, but then directs the balance in the trust to the children, who will get a stepped-up basis in those assets.

Now consider the individual with a nontaxable estate who would like to use a QTIP trust instead of exemption to (1) eliminate estate tax upon his or death, thereby allowing his or her surviving spouse to ‘port’ more exemption for future use, (2) enable more of the parents’ combined estates to get a stepped-up basis when it passes to the children, and (3) gain the non-tax benefits of the QTIP.

The planning conundrum facing this individual begins with Rev. Proc. 2001-38. Rev. Proc. 2001-38, which obviously pre-dated portability, provides a procedure whereby the IRS would grant relief for a mistaken QTIP election by an estate that did not need that election to reduce its estate tax liability. This individual’s estate would not need a QTIP election to reduce the estate tax liability to zero.

After portability was introduced in 2010 and made permanent in 2012, the concern was that, because of Rev. Proc. 2001-38, the executor of a nontaxable estate could not file an estate tax return that made both a portability election and a QTIP election, i.e., the IRS would not recognize the QTIP election.

While largely regarded by planners as a technical ‘glitch’ waiting its turn for correction, the final portability regulations did not address the problem by clarifying that both elections could in fact be made. Now, recognizing that some nontaxable estates might like to make a QTIP election for the purposes noted above, the IRS released Rev. Proc. 2016-49, which modifies and supersedes Rev. Proc. 2001-38, giving otherwise nontaxable estates the flexibility to elect portability and make a QTIP election. The revenue procedure still sets forth procedures to disregard and treat as null and void for transfer tax purposes a QTIP election in situations where the QTIP election wasn't necessary to reduce the estate tax liability to zero. However, in estates in which the executor made the portability election, QTIP elections will not be treated as void.

Rev. Proc. 2016-49 is indeed welcome clarification for those individuals who would like to design their estate plans so that they don’t necessarily have to compromise their tax objectives to address important personal concerns.


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