[IMGCAP(1)]The legislation passed by Congress at the end of 2010 to extend the Bush tax rates for another two years is bad news for estate planning practitioners.
The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 expanded the exemption equivalent to the estate tax credit (“exemption amount”) to $5 million.
Moreover, it introduced the concept of exemption portability which, heretofore, had not been seen in Federal Estate Taxation. Under the Act, a husband and wife each have a $5 million exemption; $10 million can be sheltered from estate tax.
Moreover, to the extent that the first spouse to die does not use his or her exemption, the unused exemption is available to the surviving spouse. For example, if Rufus died with an estate of $2 million, so did not use $3 million of his $5 million exemption, that $3 million unused exemption could be used by the estate of his widow, Esmeralda, when she died.
If her rich Uncle Ebenezer died and left her $8 million, the entire amount could be sheltered from estate tax by her exemption and the exemption she inherited from Rufus. Moreover, the Act reunified the estate tax with the gift tax. Upon Rufus’s death, Esmeralda would have $8 million available, which she could use to shelter lifetime gifts from the gift tax, along with any assets passing upon her death from the estate tax.
[IMGCAP(2)]For decades, estate planning lawyers have been employed to draft and fund “A-B Trusts” to ensure that each spouse would fully utilize his or her exemption, while allowing the surviving spouse to receive all of the income from the deceased’s estate and access to the estate principal, if necessary for common living expenses (“health, education, maintenance and support”).
The introduction of portability to the estate planning rules reduces the need for A-B Trust planning as the surviving spouse will have unlimited access to the deceased’s assets during her life and can pass those assets to the next generation during life or at death up to the $5 million exemption and the amount of the exemption unused by the deceased spouse. In other words, fewer A-B trusts will be drafted.
The other bad news is potential malpractice liability exposure for practitioners representing the surviving spouse in post-mortem estate planning. Portability is not automatic. In order to preserve portability and make the unused deceased spouse’s exemption available to the surviving spouse, an election must be made on the estate tax return of the first spouse to die. Less than 1 percent of deceased estates are subject to the estate tax, as less than 1 percent of the population dies with $5 million in their possession.
Therefore, estate tax return Forms 706 will be required for very few estates. However, if the 706 is not filed and the election is not made, portability of the deceased’s unused exemption is lost.
At the December 2011 Westminster College Tax Practitioners’ Institute, attorney/CPA Michael Blackburn suggested that the Act and its portability will significantly increase 706 filing. Even if no estate tax is due upon the death of the first spouse, many will file the 706 to make the portability election.
In the example above, Rufus died possessed of $2 million in assets. No 706 is required; the need for an additional $3 million to shelter assets from death taxation upon Esmeralda’s death seems unlikely. But the inheritance from Uncle Ebenezer, or perhaps, a wrongful death settlement as a result of Rufus’s demise, could generate that need. The failure to file a 706 upon the death of the first spouse, even if technically unnecessary, may give rise to a malpractice claim, if, upon the death of the surviving spouse, there is federal estate tax liability which could have been avoided by filing the 706 and making the portability election.
Preparation and filing of the 706 is not cheap. Mr. Blackburn estimates the cost to be between $5,000 and $10,000. He indicated that simply providing the information concerning the deceased and their personal representative is not adequate. All applicable schedules must be completed; there must be appraisals or other support for the values listed on the schedules.
The provisions of the Act expire on Dec. 31, 2012 and the future is unclear. H.R. 3467 (introduced Nov. 17, 2011) would reduce the exemption to $1 million and, inter alia, eliminate portability (which would also occur if Congress takes no action). In the Green Book (General Explanations of the Administration’s Fiscal Year 2012 Revenue Proposals), the Obama administration recommends reducing the exemption level to $3.5 million but retaining spousal portability.
As a defense against potential malpractice claims, we recommend that practitioners advise clients of spousal portability and the need to filing a 706 to preserve portability, even if a return would not otherwise be required. A careful explanation should be provided, followed by a detailed letter to the client explaining portability and the need to file a 706 to preserve portability. A copy of that letter should be retained in the client file.
Donald R. Saxon and Ronald M. Mano teach accounting at Westminster College in Salt Lake City. Saxon is also of counsel at the law firm Gallagher, Callahan & Gartrell.
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