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Final regs modify and clarify earlier guidance on deceased spousal unused exclusion amount

Preamble to TD 9725, 06/12/2015; Reg. § 20.2001-2, Reg. § 20.2010-1, Reg. § 20.2010-2 , Reg. § 20.2010-3, Reg. § 25.2505-1, Reg. § 25.2505-2

IRS has issued final regs that provide guidance on the estate and gift tax applicable exclusion amount, in general, as well as on the requirements for electing portability of a deceased spousal unused exclusion (DSUE) amount to the surviving spouse and the rules for the surviving spouse’s use of this DSUE amount. The final regs generally adopt proposed regs issued in 2012, but with a number of modifications and clarifications.

Background on the portability election. Code Sec. 2010(c) allows the estate of a decedent who is survived by a spouse to make a portability election, which allows the surviving spouse to apply the decedent’s unused exclusion amount to the surviving spouse’s own transfers during life and at death. The amount received by the surviving spouse is called the deceased spousal unused exclusion, or DSUE, amount. The statutory provisions underlying the portability rules were initially enacted to apply only for the estates of decedents dying after 2010 and before 2013, but they were subsequently made permanent.

The DSUE amount is the lesser of:

1. the basic exclusion amount, or
2. the excess of (i) the basic exclusion amount of the last deceased spouse of the surviving spouse, over (ii) the amount with respect to which the tentative tax is determined under Code Sec. 2001(b)(1) on the estate of such deceased spouse. (Code Sec. 2010(c)(4))

A surviving spouse may use the DSUE amount in addition to his or her own $5 million exclusion (as indexed; for 2015, $5.4 million) for taxable transfers that the survivor made during his life or at death.

Code Sec. 2010(c)(5)(A) provides certain requirements that the executor of the estate of a deceased spouse must satisfy to allow the decedent’s surviving spouse to apply the decedent’s DSUE amount to the surviving spouse’s transfers. In particular, the executor of the estate of the deceased spouse must elect portability of the DSUE amount on a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, which must include a computation of the DSUE amount. Under Code Sec. 2010(c)(5)(A), a portability election is effective only if made on a Form 706 that is filed within the time prescribed by law (including extensions) for filing such return.

Proposed and temporary regs. In 2012, IRS issued temporary and proposed regs on the estate and gift tax applicable exclusion amount, DSUE portability election requirements, and the rules for the surviving spouse’s use of this DSUE amount. On the whole, the temporary and proposed regs responded favorably to commentators’ requests and made several important liberalizations.

Among other things, the temporary and proposed regs provided guidance on:

…making the portability election;
…the timely filing requirement;
…the requirement that the election be made on a “complete and properly-prepared estate tax return”;
…who can make the election;
…how to opt out of the portability election;
…computing the DSUE amount;
…use of the DSUE amount by the surviving spouse; and
…miscellaneous other provisions, including the effect of multiple spouses and previously applied DSUE amount, IRS’s authority to examine returns of deceased spouses, the applicability of the portability rules to nonresidents who aren’t citizens, and the applicability of portability in case of qualified domestic trusts (QDOTs).

For additional details, see Weekly Alert ¶  2  06/21/2012.

Final regs. The final regs generally adopt the proposed regs, as amended, and remove the temporary regs. Following are highlights of significant revisions made by the final regs:

Availability of extensions. In response to comments, IRS clarified that an estate, the gross estate value of which falls below the threshold amount in Code Sec. 6018 for being required to file an estate tax return, can potentially qualify for an extension of time to elect portability under Reg. § 301.9100-3 (under which IRS can grant a nonautomatic extension for making certain regulatory elections if applicable requirements are met). In other words, relief under that section may be granted to an estate that is not otherwise required to file an estate tax return. (Reg. § 20.2010-2(a)(1)) IRS noted in T.D. 9725 that, while it has published guidance regarding the availability of an automatic extension for such filers, it did not include such relief in the final regs.

Effect of election where DSUE amount is uncertain. Although the inclusion of a computation of the DSUE amount is an essential requirement of a complete and properly prepared estate tax return intended to make the portability election (Code Sec. 2010(c)(5)(A)), IRS acknowledges that there are situations in which subsequent adjustments are made that to the return that would modify the amount of the unused exclusion of that decedent. In T.D. 9725, IRS provides the example of an estate that, at the time of filing, has a DSUE amount equal to zero but also has pending claims against it that, when subsequently paid, result in unused exemption. In the example, the executor files a contemporaneous protective claim for refund, and IRS stated that the executor in this example has properly elected portability and that the recomputed DSUE amount will be available to the surviving spouse. The final regs clarify that the computation requirement in Code Sec. 2010(c)(5)(A) will be/ satisfied if the estate tax return is prepared in accordance with the requirements of Reg. § 20.2010-2(a)(7), which sets out the conditions that must be met for an estate tax return to be considered “complete and properly prepared” (and which are satisfied in the example described above). (Reg. § 20.2010-2(b)))

Requirement of a “complete and properly prepared” return. The temporary regs provided a “special rule” for estates that are otherwise not required to file an estate tax return under Code Sec. 6018 that effectively exempted the executor from the requirement of reporting the value of certain property that qualifies for the marital or charitable deduction (and sets out exceptions to this special rule). In the final regs, IRS declined to adopt a commenter’s suggestion to narrow the exceptions, but provided flexibility to refine the rules in subregulatory guidance at any time with regard to the application of the special rule to particular types of transfers. (Reg. § 20.2010-2(a)(7)(ii))

Special rules for QDOTs. The temporary regs provided that the executor of a decedent’s estate claiming a marital deduction for property passing to a QDOT should compute the decedent’s DSUE amount on the estate tax return for the purpose of electing portability in the same way the DSUE amount is computed for any other decedent. However, because the estate tax payments made from the QDOT after the decedent’s death are part of the decedent’s estate tax liability, the decedent’s DSUE amount must be redetermined upon the final distribution or other taxable event on which estate tax under Code Sec. 2056A is imposed, so the temporary regs provided that the earliest date such a decedent’s DSUE amount may be included in determining the applicable exclusion amount available to the surviving spouse or the surviving spouse’s estate is the date of the// event that triggers the final estate tax liability of the decedent under Code Sec. 2056A. However, a commenter raised concerns about this delay in using the DSUE amount as applied to a surviving spouse who became a U.S. citizen after the decedent’s estate tax return is filed and after the property passes to a QDOT for the benefit of the surviving spouse. In response, the final regs clarify that, if the surviving spouse of the decedent becomes a citizen of the U.S. and the requirements under Code Sec. 2056A(b)(12) and the corresponding regs are satisfied, such that the tax imposed by Code Sec. 2056A(b)(1) no longer applies, then the decedent’s DSUE amount is no longer subject to adjustment and will become available for transfers by the surviving spouse as of the date the surviving spouse becomes a U.S. citizen. (Reg. § 20.2010-2(c)(4); Reg. § 20.2010-3(c)(3); Reg. § 25.2505-2(d)(3))

Availability of DSUE amount by surviving spouse who becomes a U.S. citizen. The temporary regs generally prohibited a noncitizen, nonresident surviving spouse, or the estate of such a surviving spouse, from taking into account the DSUE amount of any deceased spouse except to the extent allowed under any treaty obligation of the U.S. However, in response to a comment, the final regs include a rule allowing a surviving spouse who becomes a U.S. citizen after the death of the deceased spouse to take into account the DSUE amount of such deceased spouse, provided the deceased spouse’s executor has made the portability election. (Reg. § 20.2010-3; Reg. § 25.2505-5)

Order of credits. The proposed regs didn’t set out rules on the impact of the credits in Code Sec. 2012–Code Sec. 2015 (for gift tax, tax on prior transfers, foreign death taxes, and death taxes on remainders, respectively) on computing the DSUE amount. IRS noted in T.D. 9725 that the amount of the allowable credit under those sections can be determined only after subtracting from the tax imposed by Code Sec. 2001 the applicable credit amount determined under Code Sec. 2010—thus, to the extent the applicable credit amount is applied to reduce the tax imposed by Code Sec. 2001 to zero, the credits in Code Sec. 2012–Code Sec. 2015 are not available. IRS further observed that the rule in Code Sec. 2010(c)(4) for computing the DSUE amount does not take into account any unused credits arising under those sections. Accordingly, the final regs provide that eligibility for credits against the tax imposed by Code Sec. 2001 does not factor into the computation of the DSUE amount. (Reg. § 20.2010-2(c)(3))

Effective date. The final regs are effective on June 12, 2015, and are applicable to estates of decedents dying, and gifts made, on or after that date.

References: For the DSUE amount, see FTC 2d/FIN ¶  R-7107; United States Tax Reporter Estate & Gift ¶  20,104.01; TaxDesk ¶  781,807; TG ¶  41702.