At the recently concluded 51st annual Heckerling Institute on Estate Planning in Orlando, Fla., qualified terminable interest property (QTIP) elections were discussed, particularly the issue of whether the Internal Revenue Service would respect them when a federal estate tax return was being filed solely to elect portability of the deceased spousal unused exclusion (DSUE) amount under Internal Revenue Code Section 2010(c)(5)(A). Here’s what was covered.
Preserving flexibility is a key component of estate planning in the current environment. Among the primary tools to achieve such flexibility are QTIP trusts for the sole lifetime benefit of the surviving spouse. The great advantage of QTIP trusts is that, depending on the circumstances, they can be transformed either via an election of an independent fiduciary or through the surviving spouse’s disclaimer, into a family or bypass trust for the benefit of the decedent’s surviving spouse and the decedent’s descendants.
Until recently, however, there’d been an open question concerning whether the IRS would respect QTIP trusts in certain instances when a federal estate tax return was being filed solely to elect portability of the DSUE amount under IRC Section 2010(c)(5)(A).
Revenue Procedure 2016-49
Rev. Proc. 2016-49 answered in the affirmative the question of whether the IRS will respect a QTIP election when the executor has elected portability of the DSUE amount. A “QTIP election” is an election under IRC Section 2056(b)(7) to qualify for the estate tax marital deduction a trust for the sole lifetime benefit of a surviving spouse that pays out all of its income annually to the surviving spouse and meets certain other criteria. “Portability” pertains to the carryover of the DSUE amount of the first spouse to die to the surviving spouse for federal estate and gift tax purposes and requires that an election be made by an executor on a timely-filed federal estate tax return. This revenue procedure confirms that a QTIP election will indeed be respected in a portability situation.
Some historical background is helpful in understanding the significance of this revenue procedure. We must turn back the clock to 2001, prior to the advent of portability. In Rev. Proc. 2001-38—in an attempt to be helpful to taxpayers—the IRS held that a QTIP election is null and void and will be disregarded by the IRS if it’s unnecessary to reduce the amount of the federal estate tax liability. This could occur, for example, when an estate is below the threshold for having to file a federal estate tax return, but the executor nevertheless files the federal estate tax return to commence the running of the statute of limitations. A QTIP election in this context could produce adverse estate, gift and generation-skipping transfer tax consequences, including causing a surviving spouse’s subsequent gift of an income interest in a QTIP trust to trigger the rule of IRC Section 2519 that produces a deemed gift of the principal of the entire QTIP trust for federal gift tax purposes. Against this backdrop, the IRS lent taxpayers a helping hand in Rev. Proc. 2001-38 by assuring taxpayers that an unnecessary QTIP election would be disregarded for tax purposes.
The effect of Rev. Proc. 2001-38 became somewhat murky with the advent of portability, which was first introduced for spouses dying on or after Jan. 1, 2011 and became a permanent feature of the federal estate and gift tax laws in 2013. In many instances, the executor will both: (1) elect portability of the DSUE amount, and (2) make a QTIP election on the estate tax return of the first spouse to die to produce estate tax inclusion (and therefore a step-up in basis to fair market value (FMV) for income tax purposes) on the surviving spouse’s death. In 2017, a combined amount of $10.98 million ($5.49 million per spouse) can be shielded from federal estate tax for a married couple when both spouses are U.S. citizens or residents. Producing estate tax inclusion on the surviving spouse’s death won’t necessarily generate any federal estate tax given the magnitude of the exemption—indeed, it could produce a tax-free step-up in basis for income tax purposes (which is highly desirable). If, however, Rev. Proc. 2001-38 caused the QTIP election to be disregarded for estate tax purposes, the portability-based plan of maximizing a tax-free step-up in basis on the second spouse’s death would be frustrated.
Fortunately, Rev. Proc. 2016-49 has come to the rescue. This new revenue procedure modifies and supersedes Rev. Proc. 2001-38 and provides that a QTIP election made by an executor who has also made a portability election won’t be disregarded.
A New Wrinkle
There’s a wrinkle to this revenue procedure, as Rev. Proc. 2016-49 will continue to treat as null and void certain QTIP elections that are made in non-portability situations when a number of requirements are satisfied. These requirements include the submission of specified documentation in connection with:
- a supplemental Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, that’s filed for the estate of the predeceased spouse within the applicable statute of limitations period,
- a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, filed by the surviving spouse, or
- a Form 706 filed for the estate of the surviving spouse.
Significantly, however, Rev. Proc. 2016-49 confirms that a QTIP election isn’t treated as null and void if the executor makes a portability election in accordance with IRC Section 2010(c)(5)(A). Accordingly, an estate plan for a married couple that’s designed to elect portability of the DSUE amount—including to maximize the tax-free step-up in basis on the death of the surviving spouse (generally to FMV at the surviving spouse’s date of death)—can proceed undeterred by any risk that IRS will disregard the QTIP election.