The Trouble With “Portability”

Frank died in 2012.  His estate elected the deceased spousal unused estate tax exclusion (DSUE), in an amount of $1.2 million—or the “portable” estate tax exemption, as it is more commonly referred to by non-lawyers.  An estate tax return was filed showing no estate tax due, and the IRS sent a closing letter to the estate.

Frank’s surviving spouse, Minnie, died in 2013.  Even with the additional exclusion, her estate was large enough to trigger a federal estate tax of over $700,000.  Minnie’s estate tax return was selected for audit.  She and Frank had made taxable gifts of nearly $1 million about ten years before they died.  The gifts had been reported properly on gift tax returns when they were made, but apparently the taxable gifts were not handled properly on the estate tax returns.  More than three years after Frank’s death, the IRS took another look at his estate tax return, and it determined that the DSUE should have been much lower, by about $1 million.  That didn’t change the estate tax for Frank’s estate, but it did boost taxes for Minnie’s estate, to the tune of another $788,165.

Before the Tax Court, Minnie’s estate argued that the IRS was barred from reexamining Frank’s estate tax return, either because of the three-year rule or because a closing letter had been issued.  Neither reason is applicable in this case, the Tax Court held.  The section of the tax code that grants the taxpayer’s right to claim an unused exclusion amount also explicitly gives the IRS the power to re-examine the facts giving rise to the exclusion without regard to any time limits whatsoever.  The estate tax deficiency was upheld.

The advent of the portable exclusion has been a boon to married couples in their estate planning, as they can double the amount of the federal exclusion without resorting to multiple trusts.  However, the lack of finality over the value of the DSUE is a lingering problem that deserves legislative attention.