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.

Remember The Port

One thing about this blog is that it likely reflects what’s happening here at Intergalactic Command.

Here goes: it is unlikely that you will need an extensive and expensive estate tax plan, unless you (a) have unique family issues, such as a special needs child, or (b) have a tractor-trailer load of money.

Pass away in 2018 and you will not have a federal estate tax until you get to $11.2 million.

OBSERVATION: This amount increased under the new tax bill.

Folks, that excludes almost everybody.

I suppose you could live in a state with a state estate tax, like Illinois. If you do, here is some tax advice: move.

So how do you get into the federal estate tax?

It is easy enough in concept.  

Here goes:

                          Net FMV of assets you die with

                                           Plus

                    Reportable gifts made over your lifetime

BTW, notice that assets you die with and assets you gifted away are added together. The IRS is going to tax you whether you kept stuff or gave it away. The nerd term for this is “unified” tax.

There are tricks and traps to “assets you die with,” but, for the most part, it means what it says. The “net” means you get to deduct your liabilities from your assets. The “FMV” means fair market value. Take a car for example. You might get its FMV from Kelly Blue Book.

What does “reportable gifts” mean?

Let walk around the block on this. Let’s say you made a gift to a family member in 2017. Do you have to report it?

Depends on the amount. For 2017 the annual gift tax exclusion was $14,000. This means that you could gift anyone on the planet $14,000 and the government did not need to know. If you were married, then your spouse and you could double-up, meaning that together you could gift $28,000 without the government needing to know.

Let’s say that you are single. You gifted someone $50,000 in 2017. What have you got?

Easy enough: $50,000 – 14,000 = $36,000 is reportable. Yep, you went over the limit. You have to file a gift tax return.

Mind you, it is very unlikely that you will have any gift tax due on that return.

Why not?

Let’s circle back to the formula:

                             

                          Net FMV of assets you die with

                                           Plus

                    Reportable gifts made over your lifetime

You haven’t died yet, so the first line is zero.

But you still have the second line.

Remember that you can die in 2018 with $11.2 million and not be taxed.

Folks, if someone has gifted over $11.2 million (mind you, this is over a lifetime), please call or e-mail me. I want to get into that person’s will – I mean, I want to develop a lifelong friendship with a kindred soul.  

What if you fudge the numbers? You know, play down the gifts a bit? Who will know once you are gone, right?

If you are married, there could be a hitch with this.

Let’s take a look at the Estate of Sower case.

Frank Sower passed away in 2012, leaving Minnie as his surviving spouse. He filed an estate tax return, and it showed an unused estate tax exclusion of $1,250,000.         

COMMENT: Beginning in 2010, any unused estate tax exclusion of the first-to-die spouse could carryover to the surviving spouse. For example, the exclusion for 2011 was $5 million. Let’s say that the first-to-die had a taxable estate of $3.6 million. The balance - $1.4 million – could transfer to the surviving spouse.

This was a big improvement in tax practice. Previously tax professionals used trusts – “family” trusts and “marital” trusts, for example - to make sure that estate tax exclusions did not go squandered. One can still use trusts if one wants, but it is not as mandatory as it used to be. The transfer of the unused exclusion to the surviving spouse is called “portability” (“port” to the nerds) and it required (and still requires) the first-to-die to file a federal estate tax return, whether otherwise required, if only to alert the IRS that some of the exclusion is being ported.

There was however a problem with Frank’s estate return: the preparer left out $940,000 of reportable gifts. That in turn meant that the unused exclusion was overstated, as those unreported gifts would have soaked up a chunk of it.

Minnie died in 2013. Her estate showed the unused exemption ported from Frank. It was wrong, but it was there. The same tax preparer must have done her estate return, as once again her reportable gifts were left off.

The IRS audited her estate return and caught the mistake. They wondered whether Frank’s return had the same issue. It did, of course, so the IRS adjusted Frank’s ported exemption.

When the dust settled, Minnie’s estate owed another $788,165.

Ouch. Folks, the estate tax has one of the highest rates in the Code. A lot of effort goes into minimizing this thing. At least Congress has gotten away from having  taxable estates begin at $600,000, as it did in the nineties. Average folk did not consider $600,000 to be “wealthy,” no matter what Congress and the grievance mongers said.

The estate litigated. They argued that the Frank’s estate had a closing letter (think magical letter, but the estate’s letter was non-magical); that the adjustment to the port was an impermissible second review of Frank’s return; that the IRS position improperly overrode the statute of limitations, and so on. The estate lost on all counts.

What do we learn from Sower?

         

(1) It is OK to port.

(2) But the IRS can adjust the port if you get it wrong.

What did we learn from this post?

Remember the port.