Post Mortem Estate Planning

Further Steps Can Be Made After Death to Increase Tax Savings

Post mortem estate planning provides both the opportunity to maximize the amount of property received by the deceased’s intended beneficiaries, and to minimize the tax burden on the estate. While the estate plan created during the deceased’s lifetime establishes the roadmap or outline for the disposition of their estate upon their death, the executor of the estate may still need to make elections, or take certain actions. The chosen elections and actions can make a large difference in the amount of property received by the decedent’s intended beneficiaries, while minimizing the tax burden on the estate. For example, the executor may make elections regarding matters ranging from the treatment of medical expense deductions on the decedent’s final income tax return to the payment or deferral of the estate tax. Like the executor, beneficiaries may also alter the estate plan, rearranging the distribution of property by using disclaimers, as well as through applications for family awards and allowances.

The first topic discussed in this article will be filing requirements. This topic will cover all of the filings that the executor of the estate will be responsible for filing, both at the state and federal level. The second topic covered is disclaimers, especially their use in decreasing the property passing to a named beneficiary and increasing the amount of property passed on to others. The third topic is Income in Respect to Decedent (IRD). This section will explain what IRD is, and mention a commonly missed deduction. The fourth topic will discuss valuation issues. Specifically, this section will address the alternate valuation method available under I.R.C. §2032 and the special use valuation under I.R.C. §2032A. The fifth topic discusses deductions and elections, focusing on methods to reduce the amount of estate tax that needs to be paid. Finally, the sixth topic will introduce allowances and elections available to surviving family members of the deceased. Specifically, this section will discuss the widow’s election or spousal share provided for in most noncommunity property states.

Filings

The executor of the estate will have to make two sets of fillings: state and federal. At the federal level the executor is responsible for filing both the decedent’s final personal income tax return, the decedent’s estate (and generation-skipping transfer) tax return, and the decedent’s final gift tax return. State level filings will vary from jurisdiction to jurisdiction depending upon whether the state has an estate or death tax, an income tax, or a gift tax.

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The Decedent’s Final Income Tax Return

A final personal income tax must be filed on behalf of the decedent by April 15 of the year following the decedent’s death. I.R.C. §§ 6012(b)(1), 6072(a); Treasury Reg. §1.6072-1(b). The return should cover the period beginning January 1 of the year of death until the decedent’s date of death. I.R.C. §443(a)(2). For example, if Mr. Reaper dies on May 1, 2011, his final personal income tax return should cover all income earned between January 1, 2011 and May 1, 2011, and must be timely filed by April 15, 2012. If in the unlikely event that the decedent filed on the basis of a fiscal year, the decedent’s final return is due on the fifteenth day of the fourth month following the close of the decedent’s fiscal taxable year. Treasury Reg. §1.6072-1(b). Finally, it is worth noting that if a decedent dies early on in the year the executor may be responsible for filing two tax returns: the decedent’s tax return for the prior tax year, and the decedent’s final income tax return.

Any tax owed to the federal government must be paid when the income tax return is due. However, an extension of six months may be granted. I.R.C. §6161(a)(1). An extension will be granted only if a satisfactory showing can be made that payment on the due date will result in an undue hardship. Treasury Reg. §1.6161-1(b).

Example: Mr. Reaper dies on January 20, 2011. The executor of his estate is responsible for filing two federal income tax returns. The first return, which is due on April 15, 2011 encompasses all of the income Mr. Reaper earned during the 2010 tax year. The second return is the decedent’s final federal income tax return. This return is due on April 15, 2012, and should report all income earned by Mr. Reaper between January 1, 2011 and January 20, 2011.

A joint return may be filed for the decedent and their surviving spouse if the surviving spouse does not remarry before the end of the year, and the length of the tax year either has not been shortened by reason of a change of accounting period. I.R.C. §6013(a)(2). A joint return will include the income earned by the decedent from January 1 of the year of death until the date of death, and all income the surviving spouse earned for the entire taxable year. Such a return must be made by both the executor and the surviving spouse. I.R.C. §6013(a)(3). If no executor has been appointed, the surviving spouse may file the joint return; however, if an executor is later appointed, the executor may disaffirm the joint return within one year of the last day for filing the surviving spouse’s return. I.R.C. §6013(a)(3).

Filing a joint return more often than not will result in a lower overall income tax liability than if separate returns were filed. This will occur where, for example, the deceased spouse receives a large amount of income in his final taxable year, and his spouse has received little to no income in that same taxable year. Likewise, the results would be the same in the converse situation, where the surviving spouse had a large income, and the deceased spouse had little to no income. Further, filing a joint return allows the decedent and the surviving spouse to make the best use of the income tax deductions attributable to a decedent’s final taxable year. As these deductions cannot be carried over to the decedent’s estate, if a joint return is not filed, these deductions will go to waste.

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Example: Mr. Reaper, the decedent, made charitable contributions prior to his death exceeding the amount that is deductible when measured by his contribution base alone. If the executor of Mr. Reaper’s estate and Mrs. Reaper, his surviving spouse, file a joint return a larger charitable contribution deduction would be allowed because the contribution base would now include both Mr. Reaper and Mrs. Reaper’s incomes. However, if no joint return was filed, the portion of the charitable deduction that was not allowable as a deduction on Mr. Reaper’s final return would be wasted, as the excess is not then deductible on Mr. Reaper’s estate tax return. See Treasury Reg. §1.170A-10(d)(4)(iii).

Likewise, another advantage to filing a joint return exists where the decedent recognized a net capital loss in their final taxable year, and the surviving spouse recognized a net capital gain. A net capital loss is deductible up to $3,000 when filing a joint return, and $1,500 if filing a separate return. However, if a joint return is filed, the decedent’s capital loss could offset some or all of the net capital gain recognized by the surviving spouse.

Example: Mr. Reaper dies having suffered a $3,000 capital loss. In the year of his death, Mrs. Reaper recognizes a $3,000 capital gain. If a joint return is filed, Mr. Reaper’s capital loss can be used to offset Mrs. Reaper’s capital gain.

While filing jointly has many advantages, it does have one major disadvantage. A jointly filed return creates joint and several liability upon the decedent’s estate and the surviving spouse for the amount of taxes, interest, and penalties due. I.R.C. §6013(d)(3). However, I.R.C. §6015, known as the “innocent spouse” provisions, provides that an estate may not be liable where the executor did not know and had no reason to know that the joint return substantially understated the income of the surviving spouse attributable to grossly erroneous treatment of items of income, deductions, credits, or bases. See I.R.C. §6015.

The Estate Tax Return

The executor of the decedent’s estate is responsible for filing the Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return. The return must be filed within nine months of the date of the decedent’s death, with the possibility of receiving a six month extension. In order to receive the six month extension, Form 4768 Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes must be filed no later than the due date for filing the estate tax return. Likewise, the full amount of estate tax owed is due nine months from the decedent’s date of death, unless the executor has requested and been granted the permission to pay in installments under I.R.C. §6166, or to pay part of the tax attributable to a reversionary or remainder interest at a later time under I.R.C. §6163.

Example: Mr. Reaper dies on March 29, 2011. The executor of Mr. Reaper’s estate must file the Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return within nine months from Mr. Reaper’s date of death; this requires that Mr. Reaper’s estate tax return be filed no later than December 29, 2011. If the executor of the estate cannot file the Form 706 by that date, he must file a Form 4768 Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes.

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Disclaimers

A disclaimer is an unequivocal refusal to accept an interest in, or a power over, property that the disclaimant (the person making the disclaimer) is otherwise entitled by a lifetime transfer, a transfer at death, or through operation of law. Generally speaking, a disclaimed piece of property passes as though the disclaimant had predeceased the decedent. As a result, disclaiming is an effective manner of decreasing the property passing to a named beneficiary and to increase the amount of property passed on to others. This opportunity to reorder the distribution of property – free of tax – is one of the most important tools that an estate planner has. However, before recommending that a client disclaim their interest in a piece of property a lawyer must know of the client’s family circumstances and be aware of the impact of all the relevant state laws. See, e.g., Webb v. Webb, 301 S.E.2d 570 (W.Va 1983).

Most state laws require that a disclaimer occur within a reasonable time of the original transfer occurring, and must be made without consideration. The acceptance by the disclaimant of any benefit from the transfer generally precludes a valid disclaimer. In some states, disclaimers by insolvent individuals are prohibited as a means to protect creditors.

Qualified Disclaimers under I.R.C. §2518

Any disclaimer satisfying the requirements set forth in I.R.C. §2518 is a “qualified disclaimer.” I.R.C. §2518(b) states that: [T]he term “qualified disclaimer” means an irrevocable and unqualified refusal by a person to accept an interest in property but only if such refusal is in writing; such writing is received by the transferor of the interest, his legal representative, or holder of the legal title to the property to which the interest relates not later than the date which is 9 months after the later of the day on which the transfer creating the interest in such person is made, or the day on which such person attains the age of 21; such person has not accepted the interest or any of its benefits, and as a result of such refusal, the interest passes without any direction on the part of the person making the disclaimer and passes either to the spouse of the decedent, or to a person other than the person making the disclaimer.

A qualified disclaimer is effective for gift and estate tax purposes. Thus, under I.R.C. §2518, if a person makes a qualified disclaimer with respect to an interest in a piece of property, the gift and estate tax laws apply as if the interest had never been transferred to the disclaimant. Disclaimers made for consideration do not qualify as qualified disclaimers under I.R.C. §2518.

A power with respect to property is generally treated as an interest in that property, and may therefore be disclaimed. I.R.C. §2518(c)(2). A power that is disclaimed normally terminates. However, as is the case of other interests, a power may be partially disclaimed. See Treasury Reg. §25.2518-3(d), example 21.

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Statutory Requirements for Qualified Disclaimers

In order to satisfy the requirement set forth in I.R.C. §2518, Regulation §25.2518-2(a) requires that:

First, the disclaimer be irrevocable and unqualified;

Second, the disclaimer be in writing;

Third, the writing be received by the transferor or their legal representative no later than the date that is nine months after the later of the date on which the transfer creating the interest in the disclaimant is made or the day on which the disclaimant attains the age of 21;

Fourth, the disclaimant has not accepted the interest disclaimed or any of its benefits; and

Fifth, the interest disclaimed passes either to the spouse of the decedent or to a person other than the disclaimant without any direction on the part of the person making the disclaimer.

The irrevocable and unqualified requirement mandates that the disclaimer be irrevocable and unqualified, which does not usually pose any problem for the estate planner. Just to be cautious, a disclaimer should always state that it is irrevocable and is not subject to any qualifications and/or conditions. Likewise, the writing requirement is unlikely to cause a serious problem for the estate planner.

The disclaimer, in order to be a qualified disclaimer, must be received within nine months after the date on which the original transfer was made. For purposes of satisfying this nine month period, a timely mailing will be treated as a timely delivery if certain mailing requirements are satisfied.

If the person disclaiming their interest has received any benefit from the property interest, they cannot satisfy the requirements of a qualified disclaimer. A disclaimant will be treated as having accepted a benefit from the property if the disclaimant receives any consideration in exchange for the disclaimer.

The requirement that the property pass to the decedent’s surviving spouse or to a person other than the disclaimaint without any direction on the disclaimant’s part can be troublesome, especially where a trust is involved. A disclaimant may have to disclaim the right to receive a particular interest by more than one method in order to satisfy this requirement.

Disclaimer Planning

A disclaimer can be used effectively in a wide variety of situations. A few of these situations are outlined below.

Skipping a Generation: A decedent’s children may be financially secure, and thus may disclaim the right to receive an outright bequest. This disclaimer will allow the property to pass to the disclaimant’s children outright or to a trust for their benefit. Such a disclaimer would create generation skipping transfer tax implications.

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Increasing or Decreasing Gifts to a Surviving Spouse: A surviving spouse can disclaim the right to receive property that would be sheltered from federal taxation by the decedent’s unified credit. Using a disclaimer in this situation will help limit the size of the surviving spouse’s gross estate.  For instance, a disclaimer that is either full or partial over a marital deduction trust could move assets to an underfunded credit shelter trust which is sometimes referred to as the Bypass Trust or the Family Trust.

Eliminating a Generation Skipping Transfer: A grandchild or a more remote descendant may disclaim a bequest in a way that will prevent a generation skipping transfer from taking place.

Avoiding Multiple Administration and Unnecessary Taxation: If a beneficiary dies within nine months of the decedent, the beneficiary’s personal representative may disclaim the right to receive property from the decedent’s estate in order to avoid multiple administrations and multiple taxation of the same property.

Disclaimer by Surviving Spouse: The personal representative of a surviving spouse may disclaim the right to receive property from a predeceased spouse’s estate. The planner should be aware that in some circumstances a surviving spouse’s disclaimer can produce adverse tax consequences.

Medicaid Planning: A person who receives a gift or bequest may lose their qualification to receive Medicaid benefits. State law may allow either the recipient of their legal guardian to disclaim the interest. However, some states now treat disclaimers as a transfer of resources for Medicaid purposes.

Income in Respect of Decedent (IRD)

Income in Respect of Decedent (IRD) is the name given to all forms of taxable income earned, but not received by the decedent by the time of his or her death. IRD is not taxed on the final return of the decedent, and instead goes on the return of the person or entity receiving the income. This can be the surviving spouse, the estate, or on occasion some other beneficiary.

IRD retains the same tax nature after death as it would have had if the decedent had received the income while still living. IRD items do not receive a step-up in basis. Common forms of IRD include annuities, IRAs and retirement plans, Series EE U.S. Savings Bonds, and wages and vacation time paid after death.

One of the most commonly missed deductions available to the recipients of IRD is the estate tax deduction attributable to the IRD items. Since the amount was earned while alive, and thus due to the decedent at the time of their death, it is an asset of the estate. The IRD estate tax deduction is calculated by re-computing the 706 without any of the items of IRD, then subtracting this number from the true federal estate transfer tax bill. This difference is the estate tax due to the IRD items. A proportionate amount of this may be deducted not subject to the 2% of AGI (Adjusted Gross Income) limit, by the recipient as they realize the income from the IRD item.

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Valuation Issues

Prior to 1935, the gross estate was valued on the date of death and the federal estate tax was due one year later. As a result of significant declines in the value of property that occurred during the Great Depression the estate tax often amounted to a disproportionately large portion of the value of the estate on the payment date. In 1935, the alternative valuation method was added to the Internal Revenue Code. Today the alternative valuation method is codified under I.R.C. §2032.

According to I.R.C. §2032, property included in the gross estate is valued as of the time of the decedent’s death unless the executor makes a timely election on the estate tax return to value the gross estate according to the alternative valuation method. If a timely election is filed, all items are valued in the following manner:

First, property distributed, sold, exchanged, or otherwise disposed of within six months of the decedent’s death is valued as of the date of distribution, sale, exchange, or other disposition.

Second, property not distributed, sold, exchanged, or otherwise disposed of within six months after the decedent’s death is valued as of the date six month after the decedent’s death.

Third, items that are affected by the mere lapse of time are included at their values as of the date of death, adjusted for any differences in value that are not due to the mere lapse in time.

Obviously, the choice of valuation date affects the valuation of assets for estate tax purposes, and has a direct affect on the size of the gross estate. The estate tax valuation of assets also establishes their bases for income tax purposes. I.R.C. §1014(a). Therefore, the use of alternative valuation date will have an impact on the income tax liability of estates and distributees. The gain or loss realized on the sale of property acquired from the decedent is long-term by definition. See I.R.C. §1223(11). Under the provision, a person to whom property passes from a decedent is considered to have held the property for more than one year.

The alternate valuation method may be elected only if the election will decrease both the value of the gross estate and the sum of the estate and generation-skipping transfer taxes. I.R.C. §2032(c). Therefore, the alternate valuation method may not be elected if it will increase the value of the decedent’s gross estate, thus increasing the amount of estate and generation-skipping transfer taxes due.

Income Tax Impact of Using Alternate Method Valuation

If the alternate valuation method is used, all assets that are sold, exchanged, distributed, or otherwise disposed of within the first six months after the decedent’s death are valued at their value on the date of their disposition. Therefore, where the alternate method is elected, the estate will not recognize any gain or loss on sales or exchanges made within the first six months following the decedent’s death. All assets that are not sold or otherwise disposed of during the first six months are valued according to their respective fair market values at the end of the six month period.

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Property Affected by Alternate Method Valuation

Property that forms a part of the decedent’s gross estate at the time of death is included property subject to the alternate valuation method found in I.R.C. §2032. Any included property remains included, even though the property may change form during the six month period (ex: from a tangible asset to cash). Property earned or accrued after the date of death is considered excluded property that is not taken into account for the alternate valuation method.

Distributed, Sold, Exchanged, or Otherwise Disposed Of

The term “distributed, sold, exchanged, or otherwise disposed of” describes all possible ways that property ceases to form a part of the decedent’s gross estate. Reg. §20.2032-1(c). The term does not extend to mere changes in form. Thus, it does not apply to a tax-free exchange of stock in a corporation for stock in the same corporation, or in another corporation such as in a merger or reorganization. Revenue Ruling 78-378 sets forth an economic benefit analysis concerned with whether the passage of property by operation of law to a decedent’s devisee constituted a distribution of the property where it remained subject to claims against the estate until a final court order. The Revenue Ruling states that: The delivery of property to the distributee that is subject to a subsequent court decree is not a delivery within the meaning of [the Code]. Under these circumstances, there is not a shifting of economic benefits until the court decree.

For purposes of the alternate valuation method under I.R.C. §2032 property may be sold, exchanged, or otherwise disposed of by the executor, a trustee, or other donee to whom the decedent transferred the property inter vivos, an heir or devisee to whom the property passes directly under local law, a surviving joint tenant, or any other person. Reg. §20.2032-1(c)(3). According to the regulations on point, entering into a binding contract for the sale, exchange, or other disposition of property constitutes a sale, exchange, or other disposition of the property on the effective date of the contract, so long as the contract is subsequently carried out.

Special Use Valuation under I.R.C. §2032A

Section 2032A permits an executor to elect to value real property that was used as a farm or in connection with a closely-held business according to its actual use rather than its highest and best use. The maximum allowable reduction under the Code is $750,000, adjusted for inflation. Generally, the value of property included in the decedent’s gross estate is usually based upon its fair market value, which takes into account the highest and best use that the property can be put to.

In order for an I.R.C. §2032A special use valuation to be elected, the decedent must have been a United States citizen or resident at the time of their death. I.R.C. §2032(a)(1)(A). The I.R.C. §2032A election is available only with respect to qualified real property, which is real property located in the United States “which was acquired from or passed from the decedent to a qualified heir of the decedent and which, on the date of the decedent’s death, was being used for a qualified use by the decedent or a member of the decedent’s family.” I.R.C. § 2032A(b)(1).

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Furthermore, two percentage tests must be satisfied in order to elect I.R.C. §2032A treatment. First, the adjusted value of real or personal property used for qualified purposes on the date of the decedent’s death must constitute fifty percent or more of the adjusted value of the gross estate. I.R.C. §2032A(b)(1)(A). Second, twenty-five percent of more the adjusted value of the gross estate must consist of the adjusted value of real property, that was owned and used by the decedent or a family member who materially participated in the operation of a farm or other trade or business for five of the eight last years.

If the executor of the decedent’s estate has substantially complied with all of the requirements necessary to claim a special use valuation under the Code, then the executor is granted ninety additional days after notification of a failure to provide the information or agreements necessary to constitute a valid election. I.R.C. §2032A(d)(3).

Election to Value Qualified Real Property Under I.R.C. §2032A

The election to value qualified real property using the special use method presented in I.R.C. §2032A must be made on the decedent’s estate tax return. I.R.C. §2032A(d). The executor must file an agreement to the election signed by all parties having an interest in the property that is binding under state law. Once made, the election is irrevocable.

I.R.C. §2032A(d)(3) requires that the I.R.S. allow an executor a reasonable period of time, but not in excess of ninety days, to make correction to an election that was timely filed and substantially complied with the regulations but failed. This opportunity to perfect a failed application generally presents itself in one of two ways. First, the notice of election does not contain all required information. Second, the agreement consenting to application is missing some signatures of the agreement does not contain some required information.

Recapture Provision

The tax benefit of the special use valuation is recaptured if the qualified heir disposes of the real property or ceases to use it for the qualified use within ten years following the decedent’s death and before the death of the qualified heir. I.R.C.§2032A(c)(1). Cessation of the qualified use occurs if the qualified heir and members of their family fail to participate in a material way in the management of the real estate for a period of more than three years of any eight year period ending after the date of the decedent’s death.

Deductions and Elections

Various costs, expenses, and losses are deductible for estate and/or income tax purposes, and may have an effect upon either the marital deduction or a charitable deduction. One group of deductions, often referred to as “deduction in respect of decedent” may be claimed for both estate and income tax purposes; however, this is not true with most deductions. From an estate planner’s perspective, the most important items are those that may only be deducted on either the income tax or estate tax return, but not both.

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Deductions in Respect of a Decedent

Regulation §1.642(g)-2 provides that “deductions for taxes, interest, business expenses, and other items accrued at the date of a decedent’s death so that they are allowable as a deduction under section 2053(a)(3) for estate tax purposes as claims against the estate, and are also allowable under section 691(b) as deduction in respect of a decedent for income tax purposes. However, section 642(g) [denial of double deductions] is applicable to deductions for interest, business expenses, and other items not accrued at the date of the decedent’s death so that they are allowable as deductions for estate tax purposes only as administration expenses under section 2053(a)(2).” The deductions for interest and taxes are allowable only to the extent that the respective requirements of I.R.C. §§ 163 and 164 are met.

Income tax deductions are allowed for miscellaneous itemized deductions only to the extent that they exceed two percent of the taxpayer’s adjusted gross income. I.R.C. §67. Section 67 miscellaneous itemized deductions include all itemized deductions other than those allowed under specific code sections enumerated therein. These sections include §163 (interest), §164 (taxes), §165(a) (losses), §170 (charitable contributions), and §642(c) (amounts paid or permanently set aside for a charitable purpose). The overall tax burden can be lessened by claiming any administration expenses subject to the two percent floor as deduction on the Form 706 estate tax return. Doing so will make full use of the deductions and may also reduce the amount of the martial deduction that must be claimed.

Deductions Allowed Only on the Estate Tax Return

Some expenses are only deductible under I.R.C. §2053 for estate tax purposes, and thus are not deductible for income tax purposes. Such expenses include, but are not limited to: funeral expenses, gift taxes, federal income taxes due in connection with the decedent’s final return or any prior return, and the debts and obligations of the decedent. Likewise, the costs incurred in selling the decedent’s residence are deductible administration expenses to the extent that the expenses were incurred for the purpose of paying the decedent’s debts and expenses of settling the estate. See I.R.C. §2053(a).

Funeral expenses are deductible on the decedent’s estate tax return so long as local law does not prohibit the deductibility of part or all of these expenses. Likewise, no deduction is allowed for funeral expenses imposed upon or paid by the decedent’s surviving spouse or other relatives. See Rev. Rul. 76-369. Similarly, in community property states that impose the liability for payment of the expenses upon the entire community, only fifty percent (50%) of the expenses are deductible on the decedent’s estate tax return. See Rev. Rul. 70-156.

An enforceable charitable pledge is deductible under I.R.C. §2053(c), and may be more advantageous to the estate than the charitable deduction allowed under I.R.C. §2055. It is important to note that charitable pledges are only deductible to the extent that they are enforceable under local law.

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Deductions Allowed Only on the Income Tax Return

Some expenses incurred after the decedent’s death are deductible for income tax purposes only, not for estate tax. These expenses include state incomes taxes on the estate’s post mortem income, real estate taxes that accrue after death, and interest that accrues after death to the extent it is not allowable as an expense of administration under local law. Estates are generally bound by the same rules on business and capital losses as individuals. Capital gains and losses retain their distinct character, separate from ordinary income.

Deductions Allowable on Either the Income or Estate Tax Return

Administration expenses and casualty losses are deductible either on the decedent’s final income tax return or on the estate tax return, but not on both. Administration expenses include the fees of the personal representative and the lawyer, which together often account for the bulk of an estate’s deductions. Treasury regulations allow deductible items to be claimed wholly on either return or partly on one return and partly on the other. See Reg. §1.642(g)-2.

Fees of personal representatives and trustees are deductible as an administration expense, so long as the expense meets the requirements of both local and federal law. Some case law, such as Estate of Grant v. Commissioner, 294 F.3d 352 (2d Cir. 2002) states that the deduction for personal representative fees is limited to the amount necessary for the proper administration of the estate. Thus, the deduction is limited to the portion of the estate, as defined by state law, subject to administration. Where, as in the Grant case, a decedent chooses to pass the majority of their estate through trust and thus limiting the portion of their property passed through their estate, the decedent has chosen to limit the estate’s tax deduction for administration expenses.

A deduction is allowed for the accrued interest on the unpaid federal estate tax when as estate has elected to make deferred payment of the federal estate tax, so long as the decedent died before 1998. Rev. Rul. 84-75. The deduction is only allowed if it is actually and necessarily incurred and is allowable under local law.

Marital Deduction QTIP Election under I.R.C. §2056(b)(7)

I.R.C. §2053(b)(7) makes the marital deduction available on an elective basis for the value of property in which a surviving spouse receives a qualifying income interest for life. A qualifying income interest is defined as on in which the surviving spouse ins entitled to all of the income for life, payable at least annually, and no other person has a power to appoint any of the property to a person other than the surviving spouse. Once made, a QTIP election is irrevocable. Thus, an estate that filed an estate tax return that mistakenly elected QTIP treatment for both the credit shelter and marital deduction trusts cannot later change that election. Regulation §301.9100 provides for an extension of time to make a QTIP election.

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Making the QTIP Election

The QTIP election must be made by the executor on Schedule M of the federal estate tax return. To properly elect the QTIP, the QTIP election must be listed on schedule M, and the value of the election must be deducted on that schedule as well. For planning purposes, the executor should make the election in a manner preserving the total benefit of the decedent’s unified credit. An over election will result in an unnecessarily large portion of the decedent’s property being included in the surviving spouse’s estate.

Reverse QTIP Election for Generation Skipping Transfer Taxes Purposes under I.R.C. §2652(a)(3)

If a reverse QTIP election is made, the decedent who created the QTIP trust continues to be treated as the transferor of the trust for generation skipping transfer tax purposes, even though the trust is includable in the estate of the surviving spouse and not the deceased spouse. In order for a reverse QTIP election to be made a trust must be divided.

According to the laws and regulations governing the generation skipping transfer tax, the transferor of property is the person who was the donor of the property for gift tax purposes or in whose estate the property was included for estate tax purposes. With a QTIP trust, the deceased spouse is treated as the transferor until the property is treated as having been transferred by the surviving spouse for either gift or estate tax purposes. As the QTIP trust is included in the surviving spouse’s estate, the surviving spouse upon death becomes the transferor of the QTIP trust for generation skipping transfer tax purposes; this shift in the tax burden acts to waste the generation skipping transfer tax exemption that the first deceased spouse was entitled to. This waste can be avoided by making an election under I.R.C. §2652(a)(3) to treat the property as if the QTIP election had not been made for generation skipping transfer tax purposes. The regulations on point require that the election, which is irrevocable, be made on the return on which the QTIP election is made. See Reg. §26.2652-2(c).

Regulation §26.2654-1(b) requires that the division of a trust be directed in the governing instrument or is authorized either by the instrument or local law, and the terms of the new trusts provide for the same succession of interest and beneficiaries. In order for a trust division to be recognized, the trust must be divided on a fractional basis, or the governing instrument requires the division to be made on the basis of a pecuniary amount.

Marital Deduction QDT Election under §2056A

Section 2056 of the Internal Revenue Code states that no martial deduction is to be allowed if the surviving spouse is not a United States citizen; however, this prohibition does not apply to “property passing to the surviving spouse in a qualified domestic trust.” I.R.C. §2056(d)(2). In order to qualify for the marital deduction for a transfer to a QDT the trust must satisfy the following criteria:

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First, the trust instrument must require that at least one trustee be an individual citizen of the United States or a United States corporation. The instrument must further provide that no distribution other than income may be made from the trust unless such trustee has the right to withhold from such distribution the tax imposed upon the distribution.

Second, the trust must satisfy any and all requirement prescribed by the Secretary of the Treasury in order to ensure payment of the estate tax imposed upon the trust.

Third, the executor must make an irrevocable election with respect to the trust on the estate tax return.

In practice, the QDT election acts to defer payment of the estate tax until the property is distributed to the surviving spouse or until the surviving spouse is deceased.

Support and Allowances

The share of a decedent’s estate that passes to the decedent’s surviving spouse or minor children may be increased if they take advantage of the family awards and allowances that are allowed under local law. The family awards generally include a limited probate homestead allowance and a limited allocation of exempt property. Perhaps the most important aspect of family awards and allowances is that they usually prevail over any contrary testamentary disposition made by the decedent. However, a surviving spouse can be barred from claiming the award if they waived the right to them in connection with a property settlement. Furthermore, the awards are often of special value because they are usually exempt from creditors’ claims against the decedent and the decedent’s surviving spouse and/or children.

Spousal Share or Widow’s Election

Most noncommunity property states have a law or laws that provide for a surviving spouse to elect to receive a specified share of the decedent’s property outright in lieu of the property they are entitled to receive under the decedent’s will. The size of this elective share and the property from which it is payable varies from state to state. The U.P.C. (Uniform Probate Code) likely provides the surviving spouse with the most generous elective share. The U.P.C. provides for a far larger property base than most states, and the elective share of the surviving spouse increase with length of the marriage. After fifteen years, a surviving spouse’s elective share would equally fifty percent of the deceased’s spouse’s augmented estate. The augmented estate includes the surviving spouse’s net estate and the decedent’s probate estate and reclaimable estate. See U.P.C. §2-202 (2008).

The interests in a decedent’s property that a surviving spouse receives pursuant to an election against the decedent’s will are considered to have passed to the surviving spouse from the deceased spouse for marital deduction purposes. Reg. §20.2056(e)-2(c). When the surviving spouse receives outright interests in property as a result of their electing to take their elective share, the interests received qualify for the marital deduction.

ELECTIVE SHARE STATUTES IN FLORIDA, RHODE ISLAND and massachusetts

In Florida, a spouse is entitled to thirty percent of the decedent's "elective estate". Florida statutory law expands the elective share beyond the traditional probate estate to include not only all property owned by the decedent, but also property given away within one year of the decedent's death, any property owned by a revocable trust, and pay on death accounts owned by the decedent.

Conversely, Rhode Island has one of the most restrictive elective share statutes in the country. Rhode Island provides the surviving spouse only a life estate in all property owned by the decedent at death.

In Massachusetts, the spousal right to an elective share is far more complicated, and varies depending on the size of the decedent's estate, as well as whether the decedent was survived by children or other family members.  Despite the recent enactment of the Massachusetts Uniform Probate Code (M.U.P.C.), the U.P.C. elective share (discussed above) was not instituted, as there are currently several longer-term reform efforts underway.  

Massachusetts's elective share is confined to the decedent's probate estate and any property held in a revocable trust created by the decedent and funded during marriage.  Under the statute, if the decedent was survived by children, the surviving spouse is entitled to one-third of the personal and real property.  If the decedent left no issue, but was survived by next of kin, then the surviving spouse is entitled to $25,000 plus one-half of the remaining personal and real property.  In either case, if the elective share exceeds $25,000 the spouse takes $25,000 plus income for life in the excess of the estate.  If the decedent was not survived by children or next of kin, then the surviving spouse is entitled to $25,000 and one-half of the remaining personal and real property.  

Conclusion

Upon an individual’s death, the executor and attorney must consider the issues discussed in this article, as well as other post mortem planning techniques. Even the best laid estate plan may require further steps to be made after a person’s death in order to maximize the benefits to the heirs.

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