IRS Updates Guidance on Unnecessary QTIP Elections to Address DSUE Portability

(Parker Tax Publishing October 2016)

The IRS has updated its procedures for disregarding and treating as void a qualified terminable interest property (QTIP) election that does not reduce an estate's tax liability. The IRS notes that while initial guidance assumed executors would not purposefully make an unnecessary QTIP election, such elections could be used to increase the deceased spouse unused exclusion (DSUE) amount eligible for portability. The new procedures generally allow a surviving spouse to void an unnecessary QTIP election as long as no DSUE portability election has been made. Rev. Proc. 2016-49.

Background

Under Code Sec. 2056(b)(7), a decedent's gross estate is reduced by the value of qualified terminable interest property. Qualified terminable interest property (QTIP) is property that passes from the decedent to the surviving spouse, where the surviving spouse has a qualifying income interest for life in the property and the executor has made a QTIP election on the estate tax return.

In Rev. Proc. 2001-38, the IRS provided relief for surviving spouses and their estates in situations where a predeceased spouse's estate made a QTIP election that did not reduce the estate tax liability of the estate (unnecessary QTIP election). Generally, the value of property for which a QTIP election was made is included in the surviving spouse's gross estate, the inter vivos disposition of an interest in the property is subject to gift tax, and in the absence of a "reverse QTIP" election, the surviving spouse will be treated as the transferor of the property for generation-skipping transfer tax purposes. As such, prior to the issuance of Rev. Proc. 2001-38, an unnecessary QTIP election produced adverse tax consequences and no benefit for taxpayers. Rev. Proc. 2001-38 provided relief by treating the unnecessary QTIP election as a nullity for federal estate, gift, and generation-skipping transfer tax purposes.

The IRS stated that Rev. Proc. 2001-38 was premised on the belief that an executor would never purposefully make an unnecessary QTIP election. However, the IRS noted that with the 2010 amendments to Code Sec. 2010(c) and Code Sec. 2505(a) providing portability elections for the deceased spouse's unused exclusion (DSUE) amount, an executor of a deceased spouse's estate may wish to elect QTIP treatment for property even where the election is not necessary to reduce the estate tax liability. A QTIP election would reduce the amount of the taxable estate, resulting in less use of the decedent's applicable credit amount and producing a greater DSUE amount than would otherwise exist. An increased DSUE amount available to the surviving spouse increases the applicable credit amount available to the surviving spouse to wholly or partially offset the surviving spouse's gift or estate tax liability that is attributable to the QTIP or any other property.

In Rev. Proc. 2016-49, the IRS has updated the procedures by which it will disregard an unnecessary QTIP election and treat such election as null and void, but only for estates in which the executor neither made nor was considered to have made the portability election. The relief provided in the revenue procedure is effective as of September 27, 2016.

New Guidance Treats Unnecessary QTIP Elections as Void, Provided No DSUE Portability Election is Made

Rev. Proc. 2016-49 treats as void QTIP elections made in cases where all of the following requirements are satisfied:

(1) The estate's federal estate tax liability was zero, regardless of the QTIP election, based on values as finally determined for federal estate tax purposes, thus making the QTIP election unnecessary to reduce the federal estate tax liability;

(2) The executor of the estate neither made nor was considered to have made the DSUE portability election; and

(3) Certain procedural requirements are satisfied.

QTIP elections made to treat property as QTIP are not treated as void in cases where:

(1) A partial QTIP election was required with respect to a trust to reduce the estate tax liability and the executor made the election with respect to more trust property than was necessary to reduce the estate tax liability to zero;

(2) A QTIP election was stated in terms of a formula designed to reduce the estate tax to zero;

(3) The QTIP election was a protective election under Reg. Sec. 20.2056(b)-7(c);

(4) The executor of the estate made a DSUE portability election, even if the decedent's DSUE amount was zero; or

(5) The procedural requirements are not satisfied.

Procedural Requirements for Relief to Treat QTIP Election as Void

In order to be eligible for relief under Rev. Proc. 2016-49, the taxpayer must identify the QTIP election and provide an explanation of why the election should be treated as void. The explanation should include all the relevant facts, including the value of the predeceased spouse's taxable estate without regard to the allowance of the marital deduction for the QTIP at issue compared to the applicable exclusion amount in effect for the year of the predeceased spouse's death. The explanation should state that the portability election was not made in the predeceased spouse's estate and include the relevant facts to support this statement.

The taxpayer must provide sufficient evidence to establish that the QTIP election was not necessary to reduce the estate tax liability to zero and that the executor opted not to elect portability of the DSUE amount. Such evidence may include a copy of the predeceased spouse's estate tax return filed with the IRS. If the executor of the predeceased spouse's estate was not considered to have made a portability election because of a late filing of that return, evidence may consist of the account transcript reflecting the date the estate tax return was filed.

The procedural requirements of Rev. Proc. 2016-49 are satisfied by submitting the above information in connection with:

(1) a supplemental Form 706 filed for the estate of the predeceased spouse;

(2) a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, filed by the surviving spouse; or

(3) a Form 706 filed for the estate of the surviving spouse.

The taxpayer must notify the IRS that a QTIP election is eligible for relief under Rev. Proc. 2016-49 by entering at the top of the Form 706 or Form 709 the notation "Filed pursuant to Revenue Procedure 2016-49."

These procedures must be used in lieu of requesting a letter ruling; accordingly, user fees do not apply to corrective action under this revenue procedure.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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