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Personal Representative Required to File Estate Tax Return to Claim Portability?

Written by Jeffrey Skatoff • July 16th, 2014

Probate Litigation,  Estate Planning,  Probate Administration,  

Background

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 authorized estates of decedents dying on or after January 1, 2011, to elect to transfer any unused estate tax exclusion to the surviving spouse. The amount received by the surviving spouse is called the deceased spousal unused exclusion, or DSUE, amount. If the personal representative of the decedent’s estate elects transfer, or portability, of the DSUE amount, the surviving spouse can apply the DSUE amount received from the estate of his or her last deceased spouse against any tax liability arising from subsequent lifetime gifts and transfers at death.

For 2014, the estate tax exclusion amount is $5.340 million.  Accordingly, if the first spouse leaves nonmarital gifts less than the exclusion amount, this unused exclusion amount can be carried over to the surviving spouse, in a concept known as “portability.”  When the surviving spouse subsequently passes away, the estate is permitted to combine the exclusion amount of the surviving spouse with the unused exclusion amount of the first spouse (the DSUE) to offset estate tax otherwise due.

The portability concept will find the most use when the spouse of less wealth (with assets less than the exclusion amount) passes first, allowing the more affluent spouse to take full advantage of both exclusion amounts.

Internal Revenue Code & Treasury Regulations Require the Filing of an Estate Tax Return to Claim Portability.

In order to allow the surviving spouse to use the DSUE for when the surviving spouse passes, the estate of the first spouse must file an estate tax return and elect portability.  Internal Revenue Code Section 2010(c)(5)(A) provides as follows:

Election required. A deceased spousal unused exclusion amount may not be taken into account by a surviving spouse under paragraph (2) unless the executor of the estate of the deceased spouse files an estate tax return on which such amount is computed and makes an election on such return that such amount may be so taken into account. Such election, once made, shall be irrevocable. No election may be made under this subparagraph if such return is filed after the time prescribed by law (including extensions) for filing such return.

Treasury Regulations expound on the requirement to file the estate tax return to claim portability.  Treasury Regulation Section 20.2010-2T provides as follows:

(a) Election required for portability. To allow a decedent's surviving spouse to take into account that decedent's deceased spousal unused exclusion (DSUE) amount, the executor of the decedent's estate must elect portability of the DSUE amount on a timely-filed Form 706, “United States Estate (and Generation-Skipping Transfer) Tax Return” (estate tax return). This election is referred to in this section and in §20.2010-3T as the portability election.

(1) Timely filing required. An estate that elects portability will be considered, for purposes of Subtitle B and Subtitle F of the Internal Revenue Code (Code), to be required to file a return under section 6018(a). Accordingly, the due date of an estate tax return required to elect portability is 9 months after the decedent's date of death or the last day of the period covered by an extension (if an extension of time for filing has been obtained). See §§20.6075-1 and 20.6081-1 for additional rules relating to the time for filing estate tax returns.

(2) Portability election upon filing of estate tax return. Upon the timely filing of a complete and properly-prepared estate tax return, an executor of an estate of a decedent (survived by a spouse) will have elected portability of the decedent's DSUE amount unless the executor chooses not to elect portability and satisfies the requirement in paragraph (a)(3)(i) of this section. See paragraph (a)(7) of this section for the return requirements related to the portability election.

(3) Portability election not made; requirements for election not to apply. The executor of the estate of a decedent (survived by a spouse) will not make or be considered to make the portability election if either of the following applies:

(i) The executor states affirmatively on a timely-filed estate tax return, or in an attachment to that estate tax return, that the estate is not electing portability under section 2010(c)(5). The manner in which the executor may make this affirmative statement on the estate tax return will be as set forth in the instructions issued with respect to such form (“Instructions for Form 706”).

(ii) The executor does not timely file an estate tax return in accordance with paragraph (a)(1) of this section.

Part 6 of the estate tax return, where portability can be claimed, can be found here, and the instructons for Part 6, here.  Note that the filing the estate tax return, coupled with the absence of an election NOT to claim portability in Section A, Part 6 of Form 706 operates as an election to claim portability.  

Who May File The Estate Return and Make the Election?

Normally, the personal representative of the estate files the estate tax return and makes the election to claim portability.  Treasury Regulation 20.2010-2T provides the following persons may file the estate tax return and make the election:

(6) Persons permitted to make the election—(i) Appointed executor. An executor or administrator of the estate of a decedent (survived by a spouse) that is appointed, qualified, and acting within the United States, within the meaning of section 2203 (an appointed executor), may file the estate tax return on behalf of the estate of the decedent and, in so doing, elect portability of the decedent's DSUE amount. An appointed executor also may elect not to have portability apply pursuant to paragraph (a)(3) of this section.

(ii) Non-appointed executor. If there is no appointed executor, any person in actual or constructive possession of any property of the decedent (a non-appointed executor) may file the estate tax return on behalf of the estate of the decedent and, in so doing, elect portability of the decedent's DSUE amount, or, by complying with paragraph (a)(3) of this section, may elect not to have portability apply. A portability election made by a non-appointed executor cannot be superseded by a contrary election made by another non-appointed executor of that same decedent's estate (unless such other non-appointed executor is the successor of the non-appointed executor who made the election). See §20.6018-2 for additional rules relating to persons permitted to file the estate tax return.

But what if the persons authorized by the regulations refuse to file the estate tax return and make the portability election?  Is there a way to force the personal representative to file the return and make the election?  Does the personal representative have any liability for failing to file the return?

Does the Personal Representative Face Liability for Failure to File the Estate Tax Return to Allow the Surviving Spouse to Claim Portability?

The language of the Internal Revenue Code and the Treasury Regulations describe the ability to claim portability as permissive, not as mandatory.  In the absence of an explicit requirement to claim portability, can there be liability? 

A fiduciary such as a personal representative owes a fiduciary duty to the beneficiaries of the estate.  Given the benefit to the surviving spouse’s estate of being able to claim the DSUE, and given the lack of any negative consequence to filing the estate tax return and claiming portability, it seems pretty easy to conclude that the personal representative has a fiduciary duty to the beneficiaries of the estate to claim portability. 

But what if the beneficiaries of the estate of the first spouse to die will not benefit from claiming portability?  Assume a second marriage with each spouse having their own children, separate property and separate estates.  Assume the surviving spouse is not a beneficiary of the first spouse’s estate, and assume that the children of the surviving spouse are also not beneficiaries of the first spouse’s estate.  Does the personal representative owe a fiduciary duty to individuals who are not beneficiaries of the estate?  Probably not. 

Indeed, does the personal representative of the first spouse’s estate owe a fiduciary duty to the heirs of the first estate to attempt to “sell” the unused exclusion amount to the surviving spouse and/or the surviving spouse’s children?  Could the heirs of the first estate sue the personal representative of the first estate for failing to capture the value of the unused exemption amount? This seems like a tough argument, because the value of the unused exclusion amount would be so speculative, given the inability to know whether the surviving spouse’s estate could make use of the DSUE. 

On the other hand, if the surviving spouse has an estate that far exceeds the exclusion amount, the value of the unused exclusion amount clearly has value.  Further, if the surviving spouse dies prior to the filing the estate tax return of the first spouse, the value of the portability election could be precisely quantified, and thus sold for a fair amount.  Unless, of course, the DSUE is an asset of the surviving spouse, in which case the personal representative may be obligated to make the portability election. 

Perhaps the personal representative has a bona fide reason for not wanting to file the estate tax return.  Suppose that the first spouse to die made aggressive lifetime gifts using family limited partnership discounts, such that the DSUE amount would be called into question were the return to be filed.  Indeed, the estate tax return could call into question all of the valuation discounts previously used, which in theory could end up having the IRS claim that the first estate was in fact a taxable estate.

What Can Be Done if the Personal Representative Refuses to File the Estate Tax Return?

1.     Negotiate with the Personal Representative to File the Estate Tax Return

Preparing and filing estate tax returns are expensive, time consuming, and expose the personal representative and his or her attorneys to potential personal liability with the Internal Revenue Service if the return is grossly in error. If the cost of preparing the estate tax return is going to be borne entirely by persons other than the surviving spouse, why should those other heirs bear the cost of the estate tax return preparation in the absence of any benefit to those heirs and in the absence of any clear requirement to file the estate tax return?  The solution is for the surviving spouse to offer the personal representative the fund necessary to prepare and file the estate tax return, and possibly also offer indemnities and other protections.

2.     Ask the Probate Court to Appoint the Surviving Spouse or an Agent of the Surviving Spouse as Administrator Ad Litem of the Estate to File the Estate Tax Return

The probate courts of most states recognize the concept of appointing additional fiduciaries of estates when circumstances so require.  If the personal representative refuses to file the estate tax return, the surviving spouse could request that the probate court appoint someone for the limited purposes of preparing and filing the estate tax return, upon which the portability election could be made.

3.     File an Action for Declaratory Relief in the Probate Court to force the Personal Representative to File the Estate Tax Return.

A more aggressive approach would be to ask the probate court to force the personal representative to file the estate tax return and make the portability election.  Given the absence of any downside to filing the return (other than the cost), the personal representative might be hard pressed to justify the refusal to file the return.

On the other hand, given that the Federal income tax laws make the claiming of the portability election optional, some state court judges might be reluctant to force the personal representative to make the election.  (If portability is such a good idea, why do the Federal tax laws make it optional?) 

If there have been unsuccessful negotiations to “sell” the portability election to the surviving spouse, those negotiations could determine the outcome of the declaratory relief action.  Perhaps the refusal of the surviving spouse to pay a reasonable sum for this valuable right could persuade the probate court not to force the claiming of the portability election.  On the other hand, given the modest cost and lack of any downside to making the claim, perhaps the probate court could be outraged by the attempt to sell the portability election.  Such outrage could, in front of some probate judges, even lead to removal of the personal representative.

4.     Have the Surviving Spouse File the Estate Tax Return Without Any Fiduciary Appointment

Finally, even though not specifically authorized by the Internal Revenue Code or Treasury Regulations, could the surviving spouse simply file the estate tax return, make the portability election, and see what happens?  Is this possible even if there is already appointed a personal representative?  If all other avenues of relief have failed, this option could be the best, and indeed the only other option.  There would seem to be no downside risk in filing the estate tax return and claiming portability even though the surviving spouse is not specifically authorized to do so.  The worst that can happen is that the DSUE is disregarded on the estate tax return of the surviving spouse when then surviving spouse dies. 

Can Anything Be Done Ahead of Time to Solve This Dilemma? 

A provision in a will directing the personal representative to file the estate tax return and claim portability would seem to be effective, and could certainly reduce the whipsaw position that the personal representative could be in - the liability for not filing the estate tax return vs. the liability to the heirs of the first estate for not trying to sell portability and/or exposing to the IRS aggressive lifetime gifting.  Another alternative would be to grant the personal representative relief from any liability in exercising the discretion to make or not make the election.  Although decisions made in bad faith would presumably not be protected under such a provision, such language would at least allow the personal representative the freedom to go about making the best decision possible for all stakeholders in the decision.

We are now recommending that wealthy couples on second (and beyond) marriages include in their marital agreements a provision that their wills direct the personal representatives to claim portability in favor of the other spouse. This should avoid potential post-death conflict between the two sets of families and eliminate the unwanted discretion that the personal representative might otherwise have. 

Jeffrey Skatoff is a Florida probate lawyer who handles administration and litigation of estates throughout the State of Florida, as well as estate planing and trust planning.