Two recent tax cases have caused a ripple in the estates and trusts community for two different reasons, both of which can significantly affect your will. This month, we examine the first case.
The first case, Estate of Rowland v. Commissioner, demonstrates how much a paperwork error can cost you or your loved ones.
When a person dies, the government permits the estate to pass a certain amount of the decedent’s money and property to family without being taxed. If a husband or wife dies and doesn’t use up their whole amount, the leftover amount can be passed to the remaining spouse to use later. This is referred to as a “portability election.”
In the Rowland case, Fay Rowland died in 2016. After the statutory deadline passed, her family tried to pass, or “port” Fay’s leftover amount to her husband, Billy, before he died in 2018. Unfortunately, the family made two mistakes. First, they didn’t file on time, and second, they failed to list exactly what Fay owned and its value. Failing to obtain an exact valuation is not permitted if some of the decedent’s money and property would pass to beneficiaries than her spouse or a charity. The court ruled that, because the paperwork had been filed incorrectly, Billy’s beneficiaries could not use Fay’s leftover amount to reduce Billy’s taxable estate. The cost of this mistake amounted to approximately $3.7 million in taxes, an amount they could never recover.
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What is a portability election?
A portability election is available only to married couples, and only after one spouse dies. If the deceased spouse’s estate doesn’t use up all of the first spouse’s estate tax exemption, the estate can elect to transfer, or “port,” the unused exemption to the surviving spouse. That transferred amount is called the Deceased Spousal Unused Exclusion, or DSUE, and the surviving spouse can use it on top of their own exemption, either for lifetime gifts or at their own death.
What made the portability election in Rowland defective?
Billy Rowland died in January 2018, two years after his wife Fay. Upon her death, her estate was worth less than the basic exclusion amount. For that reason, her estate was not required to pay estate tax. When Billy died, his larger estate attempted to use the remainder of Fay’s exemption (the unused tax exemption or DSUE) to reduce his taxable estate.
In order to do that, Fay’s estate should have filed a “timely, complete, and properly prepared” estate tax return. Unfortunately for the beneficiaries, Fay’s executor filed late in the belief that an existing safe-harbor rule (Rev. Proc. 2017-34) would protect the exclusion. However, the executor failed to file a complete and properly prepared return that is still required by the safe harbor rule. Fay’s estate tax return left the fair market value at the date of Fay’s death incomplete. Instead, it improperly relied on a relaxed valuation rule meant only for property passing entirely to a spouse or charity. In its ruling, the Tax Court found that certain valuation formulas expressed as a percentage or fraction of the gross estate necessarily require full valuation of everything in that base — and Fay’s estate plan included bequests to children, grandchildren, and a charitable foundation, not just to Billy. Because of that, the IRS couldn’t verify the numbers from an estimate alone.
As a result, Billy’s estate was permanently unable to use Fay’s unused estate tax exemption, to the tune of roughly $3.7 million.
The takeaway that matters for planning: even when a return is filed only to preserve portability and no tax is owed, sloppy or estimated valuation reporting can void the whole election — with no do-over once the deadline passes.
Stay tuned next month when we explain in the second case how a relatively small QTIP election mistake can cause a full forfeiture of your marital tax deduction.
Have questions? Need help? Call an SGW estate attorney today at 609-409-3500. Working with an estate planning attorney is money well spent to ensure you and your family are well protected.
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