Implications of DSUE Portability for Farm Estate Planning

1. Implications of DSUE Portability for Farm Estate Planning Alan Miller Farm Business Management Specialist Purdue University

2. What is the portability election? • Allows the estate of married taxpayer to pass the unused part of his/her applicable exclusion for federal estate and gift taxation ($5,250,000 in 2013) to a surviving spouse • Unused part is referred to as the Deceased Spousal Unused Exclusion (DSUE) amount

3. Measuring the DSUE amount that is portable? • DSUE amount is the lesser of: • The last deceased spouse’s applicable exclusion amount, and • The excess of the last deceased spouse’s applicable exclusion amount over the value of the last deceased spouse’s taxable estate plus adjusted taxable lifetime gifts

4. DSUE Amount Example 1 – Deceased Spouse’s Estate The outright transfers to the surviving spouse qualify for the unlimited marital deduction, and as a result they are not taxable estate transfers. The example assumes that no lifetime taxable gifts were made by the deceased spouse.

5. Portable DSUE Amount Example 1 – Surviving Spouse’s Estate Assumes that a timely filed portability election was made by last deceased spouse’s executor.

6. Portability of DSUE Amount • TRA 2010 established a portability election for deaths after December 31, 2010 • both spouses must die after this date • permits surviving spouse to use DSUE amount • ATRA 2012 extended portability to 2013 and later years

7. Marital Deduction Decreases Taxable Transfers and Increases DSUE Amount • Marital deduction is a mandatory deduction equal to value of all qualifying transfers to surviving spouse • Marital deduction directly reduces use of deceased spouse’s applicable exclusion and thus increases DSUE amount • prior to portability federal estate tax planning had focused on avoiding this result • Deceased spouse’s unused exclusion amount could be lost due to overqualifying for the marital deduction

8. How to Avoid Overqualifying for the Marital Deduction? • Transfer property to heirs who don’t qualify for marital deduction (or charitable deduction) • Transfer property to surviving spouse in a way that doesn’t qualify for marital deduction. Examples of nonqualifying transfers include: • Transfer to a so-called “credit shelter” trust • Transfer a life estate to surviving spouse

9. DSUE Amount Fixed in ValueSurviving Spouse’s Estate Appreciates Assume for simplicity that the surviving spouse owned half of all marital assets as a joint tenant with survivorship. Assume that exclusion and assets appreciate in value by 25% from 2011 to 2020.

10. Opportunities Portability Offers to Deceased Spouse’s Estate • Opportunity to correct for lack of federal estate tax planning prior to spouse’s death • Opportunity to pass estate to surviving spouse outright and yet not lose the unused DSUE amount • Postmortem opportunity to avoid overqualifying for marital deduction • Opportunity to eliminate federal estate tax liability in situations where surviving spouse’s basic exclusion plus DSUE amount is greater than surviving spouse’s taxable estate and gift transfers

11. Tax Minimizing Limitations of DSUE Portability • Failure to take full advantage of generation-skipping transfer tax exclusion (outright transfers to a surviving spouse are not generation-skipping transfers) • DSUE amount is fixed while assets transferred to surviving spouse may appreciate in value • Limited value in large marital estates with values in excess of two applicable exclusions ($10,500,000 in 2013) • How to protect the excess?

12. Example Illustrating a Taxable Gift by a Surviving Spouse Facts and circumstances: Mrs. Surviving Spouse died in late 2013. Her first husband died in 2011. His executor made the portability election for a DSUE amount of $2,000,000. Mrs. Spouse made a taxable gift of $1,000,000 in 2011 after her first husband’s death. Mrs. Spouse remarried in 2012. Her new husband died in 2013. His executor made the portability election for $4,000,000. Mrs. Spouse died later in 2013. What total DSUE amount is portable to her federal estate tax return?

13. Making the Portability Election? • A federal estate tax return must be filed for the first spouse to die • Even if filing is not otherwise required • Must be timely filed, including allowable extension • Must be complete, as provided for in regulations • Must indicate DSUE amount • Estate of surviving spouse is limited to DSUE amount of last deceased spouse • Election becomes irrevocable on due date of return

14. Will Taxpayers File A Federal Estate Tax Return Only to Elect Portability? • Notice 2011-82 stated that the Treasury Department and the Service anticipate that most (if not all) married couples will want to ensure the availability of the DSUE amount to the surviving spouse’s estate by filing a Form 706, Federal Estate Tax Return, in order to make the portability election. • It isn’t clear that taxpayers agree.

15. Adapting Neil Harl’s Three Zones to the Portability Election Decision • Zone 1 – Marital estate valued no greater than one spouse’s applicable exclusion ($5,250,000 in 2013) • Portability election as a protective election • Zone 2 – Marital estate valued no greater than both spouses’ combined applicable exclusions • Portability election as a postmortem DSUE saving election • Portability election as protective election • Zone 3 – Marital estate valued at more than both spouses’ combined applicable exclusions • More extensive pre-death tax planning required

16. Talking Points, page 1 • The portability election should be a valuable tool in some circumstances • Expect it to be of more limited usefulness than Congress intended • Remains to be seen whether or how farm estate owners’ perceptions of the need for estate planning will change • Executors of first deceased spousal estates should routinely consider whether to make the portability election • The filing requirement associated with this election and uncertainty about the size of the surviving spouse’s estate may lead to mistakes (not making the election when it turns out to be needed)

17. Talking Points, page 2 • Other estate planning alternatives, such as credit shelter trusts, generation-skipping arrangements, and valuation planning continue to offer significant federal estate tax saving advantages • Portability election likely won’t be the best alternative for accomplishing a farm estate owner’s estate planning objectives in many situations • Particularly true for large “taxable” marital estates • Particularly true when nontax objectives are considered • Now is an great time to have your estate plans reviewed

18. References • IRS Notice 2011-82, Guidance on Electing Portability of Deceased Spousal Unused Exclusion Amount, October 2011: http://www.irs.gov/pub/irs-drop/n-2011-82.pdf • IRS Notice 2012-21, Marital Portability Election Extension: http://www.irs.gov/pub/irs-drop/n-12-21.pdf • Internal Revenue Bulletin 2012-28, pp. 17-31, Temporary regulation T.D. 9593, Portability of Deceased Spousal Unused Exclusion Amount, June 15, 2012: http://www.irs.gov/irb/2012-28_IRB/ar08.html • Instructions for Form 706, U.S. Estate (and Generation-Skipping Transfer)Tax Return: http://www.irs.gov/pub/irs-pdf/i706.pdf • Congressional Joint Committee on Taxation report JCX 55-10, December 2010: https://www.jct.gov/publications.html?func=showdown&id=3716