October 24, 2016

New Guidance on Portability and QTIP Elections

The estate tax “portability” rules provide that if any portion of the tax-exempt part of the estate of the first spouse to die ($5,450,000 in 2016) is not used, then with an election made on a timely filed estate tax return for the estate of the first spouse to die, that unused portion (also referred to as the “Deceased Spousal Unused Exclusion Amount” or “DSUE amount”) can be transferred to the surviving spouse and used by that spouse on their death. Portability eliminates the need for many married couples to set up a B Trust (By-Pass Trust) when the first spouse dies to take advantage of both spouses’ estate tax exclusion.

One of the main advantages in using portability is the ability to receive a second step-up in basis on all of the assets at the death of the surviving spouse. Assets in a B Trust do not receive a second step-up in basis when the surviving spouse dies.

However, two possible drawbacks in using portability exist: (1) portability does not prevent a step-parent from disinheriting the predeceased spouse’s children on all of the estate since the survivor controls the disposition of both halves of the estate and (2) portability does not apply to the generation skipping tax therefore reducing the amount that can be put into dynasty trusts when the second spouse dies.

Clients looking to exercise control over who will eventually receive their share of the assets after the surviving spouse dies and/or were interested in generation skipping planning may have considered establishing a QTIP/Marital Trust for the predeceased spouse’s share when the first spouse died. In the past, there has been some question as to whether portability can be elected when assets pass to a QTIP Trust and not outright to a surviving spouse and a QTIP Trust may have been created only for the predeceased spouse’s share in excess of the tax-exempt amount.

The IRS in Rev. Proc. 2016-49, issued on September 28, 2016, has removed a prohibition on making a qualified terminable interest property (QTIP) election when the election would have been null and void because the estate had a zero estate tax liability. When an estate makes a portability election, this procedure allows the executor to make a QTIP election regardless of whether the election is necessary to reduce the estate tax to zero. This revenue ruling confirms that portability can be elected when assets pass to a surviving spouse via a QTIP Trust.

What does this ruling mean?

For those of you that were interested in portability but wanted to ensure (1) a second step-up in basis on all assets at the death of the surviving spouse, (2) control over the ultimate disposition of the share of the first spouse to die and (3) the ability to use the generation skipping tax exemption of the first spouse to die to maximize the amount that can be put into dynasty trusts when the second spouse dies, there is now confirmation by the IRS that portability can be elected when assets pass to a QTIP Trust and not outright to a surviving spouse.

Since an individual’s estate plan should be tailored to each family’s needs, you may wish to have a conversation with your estate planning attorney regarding portability and how this new ruling affects your estate plan.

Filed under: Estate Planning

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