Posts Tagged ‘estate tax return’

Estate Tax Portability — What If the Executor Refuses to File?

JANUARY 30, 2017 VOLUME 24 NUMBER 5
We knew it would happen, and now it has. A surviving spouse has sued to force the administrator of the deceased spouse’s estate to file a federal estate tax return to perfect the “portability” election. Before we can tell you how it turned out, we’ll need to explain the controversy.

April Villarreal died last year. Her estate was not large enough to require a federal estate tax return (that is, she did not have more than $5.45 million, the 2016 estate tax exemption amount). She and her husband Charlie had a prenuptial agreement, which provided that her assets would all go to her children — Charlie would have no interest in her estate at all.

April did not leave a will, but based on the prenuptial agreement her son Richard filed for and secured appointment as administrator of her estate in the Oklahoma courts. Actually, there were various legal moves and counter-moves leading up to that appointment, but within a few months of April’s death Richard was clearly in charge of administering her probate estate, and it had become clear that Charlie had waived any interest in her estate.

Seven months after April’s death, and after Richard had indicated he had no intention to file a federal estate tax return, Charlie filed a petition asking the court to order Richard to file a return. Clearly there was no tax liability — so why was he insistent?

That’s easy. Most people know that a surviving spouse “inherits” the deceased spouse’s federal estate tax exemption amount — or at least to the extent that it has not been used. In other words, if April left (just to pick a number) one million dollars to her children, then Charlie could receive an additional $4.45 million exemption to reduce — and possibly eliminate — the estate tax liability on his own, later, death. But that transfer only works if the deceased spouse’s estate administrator files a federal estate tax return.

Why would Richard refuse to file a return? There would not be any tax due or paid, though there would be some costs — and significant work — involved in preparing the return itself. Filing the return would not benefit April’s own estate in any way.

Richard argued that the prenuptial agreement Charlie had signed before the couple’s 2006 marriage expressly waived any interest in April’s estate. That’s true, responded Charlie — but that doesn’t mean that a benefit that costs her estate nothing and would help him should simply be allowed to evaporate. Besides, the agreement was signed before the portability benefit even existed under federal law.

The estate tax benefit, by the way, is properly referred to as the “Deceased Spousal Unused Exclusion Amount” (or DSUEA). The federal law creating a DSUEA system does not permit the injured spouse to file their own version of an estate tax return — it must be filed by the estate’s administrator (or the person who would have been the administrator, in cases where no administration is required).

The Oklahoma probate court ordered Richard to file the return. Because much of the information on the return would actually come from Charlie, the court ordered him to cooperate and provide the necessary documentation within a short period. Because the return was technically due in only about two months, the judge also ordered Richard to seek an extension for filing the return. Charlie was ordered to pay for the return’s preparation.

Richard appealed. The Oklahoma Supreme Court considered the case very quickly, and rendered its opinion upholding the trial judge. The order directing Richard to file the estate tax return, and to make the election to preserve the DSUEA for Charlie, was approved. Given the time-sensitive nature of the issues, the entire process (from Charlie’s original motion to the Supreme Court ruling) was accomplished in just five months.

The Oklahoma Supreme Court ruling makes clear that the probate court has jurisdiction to decide questions about estate administration. The mere fact that the issue was really about federal filings, not state issues, did not mean that the state court had no authority. The existence of the prenuptial agreement — especially since the right to carry over unused tax exemptions didn’t even exist at the time of the agreement — did not prevent Charlie from making his request. Estate of Vose v. Lee, January 17, 2017.

There has been much discussion in the professional probate and estate planning community about just this question. Can a personal representative (what used to be called an executor) refuse to file a return just because they don’t want to, or out of spite, or because they don’t want to be bothered? The opinion in April’s case notes that the personal representative has a fiduciary duty to the beneficiaries of the estate — and that a spouse is a beneficiary even if all they receive from the estate is the DSUEA election.

April’s case presents the argument very concisely. It’s hard to see what possible objection there might be to filing the estate tax return, where Charlie is ordered to provide all the documentation and pay the costs. The only reason to refuse the election would be the intransigence of the deceased spouse’s children. Given the blended families so common today, it seems like similar circumstances will arise with some frequency.

Bypass Trusts, Disclaimer Trusts and Portability in Estate Planning

MAY 6, 2013 VOLUME 20 NUMBER 18
Last week we wrote about questions we often hear from our clients in the wake of big changes to the federal estate tax structure. Almost immediately we heard from a reader asking about portability and disclaimer trusts; our reader suggested we try to explain the two concepts and how they are related. It’s a good idea.

First, a caveat: if you are not married OR if you are married but you and your spouse are “worth” less than about $5 million, then your interest in this topic is probably academic. That doesn’t mean you shouldn’t read on, but only that the explanation won’t affect you much — except perhaps to alert you if you have a more-complicated estate plan than you need.

Let’s start, as we often do, with a brief explanation of the classic A/B trust setup that prevailed in estate planning for married couples for nearly three decades. In an environment where estate taxes kicked in at the relatively low level of $600,000 of net worth, many couples had estate plans that created an irrevocable trust (sometimes called the “bypass” or “decedent’s” trust) on the first death. That typically allowed the surviving spouse to get the benefit of the money left to the trust, but not include it in her (or his) estate — thereby effectively doubling the $600,000 exemption amount to a total of as much as $1.2 million.

Of course, over the last decade the exemption amount rose from $600,000 to $3.5 million and then settled at $5 million (plus an annual increase for inflation). That meant that only couples with estates  of $5 million would need to create the two-trust setup, and that their estates would be covered up to a total of over $10 million with fairly simple estate planning.

But the other change made by the 2010 tax law (and made permanent effective this year) makes it harder to explain the planning options. That change is usually called “portability.” Here’s how it works:

Each spouse in a married couple has an exemption amount of $5 million (plus the inflation adjustment effective the year of that spouse’s death). If, say, the husband dies in 2013, with a $5.25 million exemption amount, but leaves his entire estate outright to his wife — she inherits his estate PLUS his exemption amount. She immediately has a $10.5 million exemption amount, and it goes up (or at least “her” half does) next year for inflation. No irrevocable trust needed. No fancy estate planning required. No legal fees, no accounting or tax preparation until the surviving spouse dies.

That’s a great outcome. It should save money for most married couples, and it is much easier to understand (and execute) than the two-trust solution. The hardest thing to understand about portability might just be its formal name: DSUEA (“Deceased Spousal Unused Exclusion Amount”).

There are, though, a number of wrinkles that well-informed planners need to appreciate. Note that these wrinkles do not mean that you should not rely on the portability arrangement. Most people will not be affected by them.

Generation-skipping tax. The generation-skipping tax exemption is a flat $5.25 million this year (it is also indexed for inflation). if you and your spouse are worth more than about $5 million AND you plan on leaving your assets to grandchildren, or in trusts for your children lasting past their deaths, then you might not want to rely on the portability arrangement.

Filing an estate tax return. The portability of the exemption amount is not automatic. The surviving spouse can only keep the deceased spouse’s exemption amount IF a federal estate tax return is filed. Say what? In order to get this benefit you have to file a return that almost no one else has to file, and to incur the expense of valuing assets (which would not have to be done otherwise)? Yes.

State estate taxes may not work the same way. Arizona, as we keep reminding clients, does not have a state estate tax. But a number of other states still do, and they will apply even to Arizona residents if they own real estate in one of those states. So portability may not be enough in cases where there are significant out-of-state assets.

Remarriage can cause loss of the portability exemption. Let’s sketch out a story. Martha’s husband David died in 2011, leaving his $2 million estate to Martha. She filed a federal estate tax return and claimed David’s $5 million unused estate tax exemption. In 2013, she has $10.25 million in exemption equivalent amount (David’s $5 million plus her $5.25 million). Note that she inherited more exemption amount from David than she inherited of actual estate value.

This year Martha’s wealthy parents died, leaving her their estate; she is now worth $8 million. She remarries. Her new husband, Hal, is a wealthy and very generous man; he has previously given his children a total of $5 million in gifts.

Does this story seem absurdly fanciful? Do you wish you had these problems? Do you want to tell Martha she shouldn’t have married Hal? Because if Hal dies, Martha “loses” David’s unused estate tax exemption, and gets Hal’s instead — and that could mean estate tax on a couple million of her estate. On the other hand, if Martha dies Hal inherits her unused exemption (the exact amount depends on who she leaves her estate to), making it possible for him to give several millions of dollars more to his children with no gift or estate tax consequences.

Can you just imagine the prenuptial agreement? And aren’t you glad that the estate tax system has been simplified?

The truth is, of course, that it has been simplified — vastly simplified, in fact, for individuals and couples worth less than about $5 million. That means most of us — about a quarter of one percent of American households are worth more than $5 million, according to some calculations.

What does all this say about disclaimer trusts? As we reported last week, having a back-up trust for your spouse might make sense in at least some circumstances, and one way to do that would be to give the surviving spouse the power to fund the trust by disclaiming the ability to inherit outright. But we predict that disclaimer trusts will be implemented infrequently.

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