A Skeleton Return And Portability

 

The amount for 2025 is $13.99 million.

This is the lifetime exclusion amount for combined gift and estate taxes. You can give away or die with assets up to this amount and owe neither gift nor estate tax. This amount is per person, so – if married – you and your spouse have a combined $27.98 million.

Next year that amount resets to $15 million, or $30 million for a married couple.

Let’s say it: most of us do not need to sweat. This is a high-end issue, and congrats if it impacts you.

What I want to talk about is the portability of the lifetime exclusion amount.

Tax practice brings its own acronyms and (call it) slang.

Here is one: DSUE, pronounced Dee-Sue and referring to the transfer of the lifetime exclusion amount from the first spouse-to-die to the second.

Let’s use a quick example to clarify what we are talking about. 

• Mr. and Mrs. CTG have been married for years.
• They have not filed gift tax returns in the past, either because they have not made gifts or gifts made have been below the annual gift exclusion. The exclusion amount for 2025 is $19,000, for example, so only a hefty gift would be reportable.
• Mr. and Mrs. CTG have a combined net worth of $20 million.
• For simplicity, let’s assume that all CTG marital assets are owned jointly.

 At a net worth of $20 million, one might be concerned about the estate tax.

Except for one thing: we said that all assets are owned jointly.

Let’s say that Mr. CTG passes away in 2026 when the lifetime exclusion amount is $15 million. His share of the joint estate is $10 million ($20 million times ½), well within the safety zone. There is no estate tax due.

Let’s go further. Let’s say that Mrs. CTG dies later in 2026.

Her net worth would be $20 million ($10 million - her half - and $10 million from Mr. CTG).

Could she have an estate tax issue?

First impression: yes, she could. She exceeded the lifetime exclusion amount by $5 million ($20 million minus $15 million).

In income tax we are used to numbers being combined when filing as married-filing-jointly. This is estate tax, though. That MFJ concept … does not apply so neatly here.

We can even create our own tax headache by having the first-to-die leave all assets to the surviving spouse.

And there is the point of the DSUE: whatever lifetime exclusion amount the first-to-die doesn’t use can be transferred to the surviving spouse. In our example, $5 million ($15 million minus $10 million) could be transferred. If Mrs. CTG dies shortly after Mr. CTG, her combined exclusion amount would be $20 million (her $15 million and $5 million from Mr. CTG). Since combined assets were $20 million, there would be no estate tax due. It’s not quite the simplicity of married-filing-jointly, but it gets us there.

Moving that $5 million from Mr. CTG to Mrs. CTG is called “portability,” and there are rules one must follow.

The main rule?

          A complete and properly prepared estate return must be filed.

Practitioners who work in this area know how burdensome a complete and properly prepared estate tax return can be. The return requires full disclosure of assets and liabilities, including descriptions and values, not to mention documentation to support the same. Here are a few examples:

•  Do you own stock? If yes, then each stock position must be valued at the date of death (or six months later, an alternative we will skip for this discussion). How do you do this? Perhaps your broker can help. If not, there is specialized software available.
•  Do you own 401(k)s or IRAs? If so, one needs to know who the beneficiaries are.
•  Do you own a business? If so, you will need a valuation.
•  Do you own real estate? If so, you will need an appraiser.

Let’s be blunt: there are enough headaches here that someone could (understandably) pass on filing that first-to-die estate tax return.

Fortunately, the IRS realized this and allowed a special rule when filing an estate tax return solely for DSUE portability.

Yes, we see the usual tax gobbledygook, but the IRS is spotting us a break when preparing the Form 706. 

• You can use (good faith) estimates. You do not have to hire appraisers and valuation specialists, for example.
• However, the special rule only applies if all property goes to the surviving spouse (the marital deduction), to charity (the charitable deduction), or a combination of the two.

Can you fail the special rule?

Yeppers.

Let’s look at the Rowland case.

Fay Rowland passed away in April 2016. She did not have a taxable estate.

The surviving spouse (Billy Rowland) passed away in January 2018. He did have a taxable estate.

Note the fact pattern: they will want to transfer Faye’s unused lifetime exemption (that is, the DSUE) to Billy, because he is in a taxable situation.

Fay’s Trust Agreement (effectively functioning as a will) instructed the following:

• 20% to a foundation
• 25% to Billy
• The remainder to her grandchildren

Fay filed an estate tax return reporting everything under the special rule: showing zero for individual assets but a total for all combined assets.

Billy’s estate return reported a DSUE (from Fay) of $3.7 million.

The IRS bounced Billy’s DSUE.

Off to Tax Court they went.

The Court agreed with the IRS.

Why?

Take a look at the special rule again.

• Assets passing to Billy qualify as a marital deduction.
• Assets passing to the foundation qualify as a charitable deduction.
• Assets passing to the grandchildren …. do not qualify for the special rule.

Fay’s estate tax return showed all assets as qualifying for the special rule. This was incorrect. The return should have included detailed reporting for assets passing to the grandchildren, with simplified reporting for the assets passing to Billy or the foundation.

Fay did not file a complete and properly prepared estate return.

The failure to do so meant no DSUE to port to Billy.

Considering that the estate tax rate reaches 40%, this is real money.

What do I think?

I have seen several DSUE returns over the last year and a half. Some have been straightforward, with all assets qualifying for the special rule. We still had to identify assets and obtain estimated values, but it was not the same amount of work as a full Form 706.

COMMENT: Practitioners sometimes refer to this special-rule Form 706 as a “skeleton” return. Skeleton refers to one providing just enough information on which to drape a portability election.

Then we had returns with a combination of assets, some qualifying for the special rule and others not. This is a hybrid return: nonqualifying assets are reported in the usual detail, while assets qualifying for the special rule are more lightly reported.

Fay’s estate tax return should have used that hybrid reporting.

Our case this time was Estate of Billy S Bowland v Commissioner, T.C. Memo 2025-76.

IRS Collection Alternatives: Pay Attention To Details

 

I was glancing over recent Tax Court cases when I noticed one that involved a rapper.

I’ll be honest: I do not know who this is. I am told that he used to date Kylie Jenner. There was something in the opinion, however, that caught my eye because it is so common.

Michael Stevenson filed his 2019 tax return showing federal tax liability over $2.1 million.

COMMENT: His stage name is Tyga, and the Court referred to him as “very successful.” Yep, with tax at $2.1-plus million for one year, I would say that he is very successful.

Stevenson had requested a Collection Due Process (CDP) hearing. It must have gone south, as he was now in Tax Court.

Why a CDP hearing, though?

Stevenson had a prior payment plan of $65 grand per month.

COMMENT: You and I could both live well on that.

His income had gone down, and he now needed to decrease his monthly payment.

COMMENT: I have had several of these over the years. Not impossible but not easy.

The Settlement Officer (SO) requested several things:

·      Form 433-A (think the IRS equivalent of personal financial statements)

·      Copies of bank statements

·      Copies of other relevant financial documents

·      Proof of current year estimated tax payments

Standard stuff.

The SO wanted the information on or by November 4, 2021.

Which came and went, but Stevenson had not submitted anything.

Strike One.

The SO was helpful, it appeared, and extended the due date to November 19.

Still nothing.

Strike Two.

Stevenson did send a letter to the SO on December 1.

He proposed payments of $13,000 per month. He also included Form 433-A and copies of bank statements and other documents.

COMMENT: Doing well. There is one more thing ….

The SO called Stevenson’s tax representative. She had researched and learned that Stevenson had not made estimated tax payments for the preceding nine years. She wanted an estimated tax payment for 2021, and she wanted it now.

COMMENT: Well, yes. After nine years people stop believing you.

Stevenson made an estimated tax payment on December 21. It was sizeable enough to cover his first three quarters.

COMMENT: He was learning.

The SO sent the paperwork off to a compliance unit. She requested Stevenson to continue his estimated payments into 2022 while the file was being worked. She also requested that he send her proof of payments.

The compliance unit did not work the file, and in July 2022 the SO restarted the case. She calculated a monthly payment MUCH higher than Stevenson had earlier proposed.

COMMENT: The SO estimated Stevenson’s future gross income by averaging his 2020 and (known) 2021 income. Granted, she needed a number, but this methodology may not work well with inconsistent (or declining) income. She also estimated his expenses, using his numbers when documented and tables or other sources when not.

The SO spoke with the tax representative, explaining her numbers and requesting any additional information or documentation for consideration.

COMMENT: This is code for “give me something to justify getting closer to your number than mine.”

Oh, she also wanted proof of 2022 estimated tax payments by August 22, 2022.

Yeah, you know what happened.

Strike Three.

So, Stevenson was in Tax Court charging the SO with abusing her discretion by rejecting his proposed collection alternatives.

Remember the something that caught my eye?

It is someone not understanding the weight the IRS gives to estimated tax payments while working collection alternatives.   

Hey, I get it: one is seeking collection alternatives because cash is tight. Still, within those limits, you must prioritize sending the IRS … something. I would rather argue that my client sent all he/she could than argue that he/she could not send anything at all.

And the amount of tax debt can be a factor.

How much did Stevenson owe?

$8 million.

The Court decided against Stevenson.

Here is the door closing:

The Commissioner has moved for summary judgement, contending that the undisputed facts establish that Mr. Stevenson was not in compliance with his estimated tax payment obligations and the settlement officer thus was justified in sustaining the notice of intent to levy.”

Our case this time was Stevenson v Commissioner, TC Memo 2023-115.

LLC Members and W-2s

There is a tax issue that has dogged advisors for years. 

It has to do with limited liability companies.

What sets it up is tax law from general partnerships.

A general partnership is the Gunsmoke of partnerships. The “general” does not means everybody participates. It does mean that everyone is liable if the partnership gets sued.

Whoa. There is clearly a huge downside here.

Which leads us to limited partnerships. Here only a general partner takes on that liability thing. A limited partner put his/her capital account at risk, but nothing more. Forget about signing on that bank debt.

Let’s present the granddaddy of self-employment tax law:

·        A general partner is considered self-employed and pays self-employment tax on his/her distributable income, irrespective of his/her own involvement in the trade or business.

·        A limited partner is presumed to not be involved in the trade or business of the partnership; therefore, he/she does not pay self-employment (SE)  tax on his/her distributable income.

o   There is an exception for “guaranteed payments, which is akin to a salary. Those are subject to SE tax.

How can we differentiate a general partner from a limited partner?

It is that liability thing. The entity is likely being formed under state “limited partnership” law rather than “general partnership” law. In addition, the partnership agreement will normally include a section specifying in detail that the generals run the show and the limiteds are not to speak until spoken to.

Then came the limited liability companies (LLCs).

These caused tax planners to swoon because they allowed a member to actually participate in the business without forfeiting that liability protection.

COMMENT: BTW the banks are quite aware of this. That is why the bank will likely request the member to also sign personally. Still that is preferable to being a general, where receipt of the partnership interest immediately makes you liable.

Did you catch the use of the word “member?” Equity participants in an LLC are referred to as “members,” not “partners.”

So how are LLCs taxed?

Like a partnership. 

COMMENT: I know. All we did was take that car around the block.

Let’s return to that self-employment issue: is a “member” subject to self-employment tax because he/she participates (like a general) or not subject because he/she has limited liability (like a limited)?

It would help if the IRS had published guidance in this area since the days of the Rockford Files. Many advisors, including me, reason that once the LLC is income-taxable as a partnership then it is also self-employment taxable as a partnership. That is what “like a” means. If you work there, it is self-employment income to you.

But I do not have to go far to find another accountant who disagrees with me.

What to do?

Some advisors allow their LLC member-clients to draw W-2s.

Some do not.

There is a problem, however: a member is not considered an employee. And one has to be an employee to receive a W-2.

The fallback reasoning for a long time has been that a member “is like” an employee, in the same sense that I am “like” LeBron James.

It is not technically-vigorous reasoning, and I could not guard LeBron with a squad of Marines by my side.

Then the IRS said that it would respect a single-member LLC as the employer of record, rather than going up the ownership chain to whoever the sole owner is. The IRS would henceforth treat the single-member as a corporate employer for employment taxes, although the single-member would continue to be disregarded for income tax purposes (it is confusing, I know).  The IRS included exceptions, examples and what-nots, but they did not include one that addressed LLC members directly.

The members-want-W-2s school used this notice to further argue their position. You have the LLC set-up a single-member subsidiary LLC and have the subsidiary – now considered a corporate employer – issue W-2s to the members. Voila!    

Let’s be clear why people care about this issue: estimated taxes. People do not like paying estimated taxes. It requires a chunk of money every three months. Members pay estimated taxes. Members would prefer withholding. Withholding comes out of every check, which is less painful, and don’t even talk about that three-month thing.    

The IRS has backed-off the member/W-2 issue for a long time.

However the IRS recently issued guidance that the above “parent-subsidiary” structure will not work, and taxpayers have until August 1 to comply. The IRS did this by firing its big guns: it issued Regulations. There are enhanced disclosure requirements when one takes a position contrary to Regulations, and very few practitioners care to do that. It is considered a “call me to book the audit” disclosure.

The IRS has given these advisors little more than two whole months to rope-in their errant LLC clients. 

Although the window is tight, I agree with the IRS on this one, except for that two-month thing. They feel they have floated the change long enough to alert practitioners. I would have made it effective January 1, 2017, if only for administrative ease. 

Still this is an area that needs improvement. While the IRS is concerned that member W-2s may lead to members inappropriately participating in benefit plans, there is also mounting demand for member withholding. 

Perhaps the answer is to allow withholding but to use something other than a W-2. One could design yet another 1099, and the member would attach it to his/her tax return to document the withholding. Any additional paperwork is a bother at the LLC level, but it would just join the list of bothersome things. The members wanting withholding would have to employ their powers of persuasion.

Sounds like the beginning of a compromise.