Portability and Prenuptials: A Plethora of Preventative, Progressive, and Precautionary Provisions

Volume 27 No. 3

By

George D. Karibjanian is senior counsel in the Boca Raton, Florida, office of Proskauer Rose LLP. Lester B. Law is a senior vice-president and wealth strategist of the National Wealth Strategies Group of U.S. Trust, Bank of America Private Wealth Management in Naples, Florida. A longer version of this article was originally published in the Bloomberg BNA Tax Management Memorandum, December 3, 2012. The article is reprinted with permission from Bloomberg BNA Tax Management (as modified for the recent changes under ATRA).

Generally, Portability is considered to be in the exclusive domain of estate planning specialists; however, it also applies to the marital planning area—especially for those attorneys who draft nuptial agreements.

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRA 2010), Pub. L. No. 111-312, 124 Stat. 3296, introduced the concept of the transferring or “porting” of a deceased spouse’s unused estate tax exclusion amount to the surviving spouse. Portability was set to expire, along with the so-called “Bush tax cuts” on December 31, 2012; however, the American Taxpayer Relief Act of 2012 (ATRA), Pub. L. No. 112-240, 126 Stat. 2313, has now made portability permanent.

Generally, portability is considered to be in the exclusive domain of estate planning specialists; however, it also applies to the marital planning area—especially for those attorneys who draft marital agreements. This article explains why portability provisions should be included in marital agreements. Portability should be understood by the drafting attorney because it is a new area of the law that will have to be both explained to, and negotiated between, the parties.

How Does Portability Work?

Before discussing the hows and whys of the sample portability provisions, a fundamental understanding of the portability concept, and the terms used within portability, is required.

Lifetime Exclusion Amount

The term “lifetime exclusion amount” is not a technical term in the Internal Revenue Code or the Regulations; rather, it is generally used to refer to the technical estate and gift tax term, “applicable exclusion amount.” An individual’s applicable exclusion amount is the combination of the taxpayer’s “basic exclusion amount” (defined below) and any “DSUE amount” (as defined below).

Basic Exclusion Amount

The “basic exclusion amount” is generally the amount of property that a taxpayer can pass tax free to those persons other than a spouse and a charity. Under TRA 2010, as made permanent by ATRA, the basic exclusion amount is $5 million with annual inflationary adjustments. In 2013, such inflationary adjustment increased the basic exclusion amount to $5.25 million. For ease of mathematical computation, the analysis and examples in this article will refer to a $5 million basic exclusion amount.

Deceased Spousal Unused Exclusion Amount

Portability introduced the term “deceased spousal unused exclusion amount” (“DSUE amount”), which is a married individual’s lifetime exclusion amount that remained unused at the time of his or her death after taking into consideration his or her testamentary dispositions.

With portability, if a married couple (1) does not implement estate planning techniques to use the lifetime exclusion amount of the first spouse to die or (2) implements the plan but does not fully use the deceased spouse’s lifetime exclusion amount, portability could potentially save the loss of any such unused lifetime exclusion amount. This is because portability allows for the transfer of the lifetime exclusion amount, in the form of the DSUE amount, to the surviving spouse, so it can be used during the remainder of the surviving spouse’s lifetime or at his or her death. But the unused lifetime exclusion amount can be transferred if, and only if, an election is made on Form 706, Federal Estate (and Generation-Skipping Transfer) Tax Return (“706”).

The Portability Election

To take advantage of portability, the regulations require that the election be made on a “timely-filed” and “complete and properly-prepared” 706. For the balance of this article, we will assume that all elections are made on a timely filed and complete and properly prepared 706.

Why Is the DSUE Amount Viewed as an Asset?

The portable DSUE amount should be viewed as a valuable asset much like a spouse’s other “separate property assets” (as such term is generally used within the marital law area). To understand the value of the DSUE amount in the context of a marital agreement, the following example may be helpful:

Example 1: H and W are negotiating a marital agreement in anticipation of their marriage, which is both parties’ first marriage. H’s net worth is $15 million and W’s net worth is $1 million. For all purposes, the basic exclusion amount is $5 million, and the applicable estate tax rate is 35%.
Under these circumstances, usually H would not ask for any financial considerations from W because H has significantly more assets than W. But, if W predeceases H and if her executors elect portability, her $4 million DSUE amount (calculated as the difference between her basic exclusion amount of $5 million and her gross estate of $1 million) passes to H. Assuming a 40% estate tax rate, this $4 million exclusion amount has an estate tax savings value to H of $1.6 million (that is, $4 million x 40%).
In other words, on H’s subsequent death, H’s estate (meaning H’s beneficiaries) will save $1.6 million in federal estate taxes. Thus, W’s DSUE amount (albeit only available at the time of her death) is a very valuable asset to H, if, and only if, W’s executors elect portability.

For this reason, W’s attorney should advise her of the potential benefit to H if she predeceases him and possibly negotiate financial considerations from H in exchange for assurances regarding the portability election.

Why Should the Lawyer Who Drafts Marital Agreements Learn About Portability?

As described above, an attorney representing a client with a marital agreement—regardless of whether he or she is an estate planning attorney or a matrimonial or family law attorney—should have a working knowledge of portability and its applicability. By understanding portability, the attorney will better understand language that should be included in the marital agreement to ensure the proper benefits for his or her client.

Model Provisions for Inclusion in Marital Agreements

This section describes the model portability provisions for inclusion in a marital agreement.

General Provision Regarding the Portability Election

There are two versions of the general or introductory portability election provision: the first version contemplates that portability will be elected regardless of which spouse dies first (that is, whether the less-wealthy spouse dies first or second), so the proposed provision would apply equally to both spouses.

(1) Portability Election. If the parties are married at the death of the first of the parties to die (the “Deceased Spouse”), the Deceased Spouse shall leave written instructions that direct his or her Portability Executor (as defined herein) to elect to transfer to the surviving party (the “Surviving Spouse”) the Deceased Spouse’s “deceased spousal unused exclusion amount” (the “DSUE Amount”), if any, as defined in § 2010(c)(4) of the Code (the “Portability Election”). Such written instructions shall direct the Portability Executor to undertake all procedures, whether statutory, regulatory, administrative or otherwise, to effect such election, which may include, but is not limited to, the filing of a U.S. Estate (and Generation-Skipping Transfer) Tax Return, Form 706, or the applicable successor or comparable form (the “706”).

The second provision applies if portability is to apply only if the less-wealthy spouse (“Party 2”) predeceases the wealthier spouse (“Party 1”):

(1) Portability Election. If Party 2 (the “Deceased Spouse”) predeceases Party 1 (the “Surviving Spouse”), and if the parties are married to each other at the time of the Deceased Spouse’s death, the Deceased Spouse shall leave written instructions that direct his or her Portability Executor (as defined herein) to elect to transfer to the Surviving Spouse the Deceased Spouse’s “deceased spousal unused exclusion amount” (the “DSUE Amount”), if any, as defined. . . .

The provision refers to the “Portability Executor” instead of the executor, personal representative, or other judicially appointed administrator of the decedent’s estate. The Regulations provide a hierarchy for who can make the portability election, stating that if there is a court-appointed executor for the deceased spouse’s probate estate, such appointed executor has priority to make the election. If, however, there is no court-appointed executor, any other person who is authorized under the Code may elect (or specifically not elect) portability. If such a noncourt-appointed person files the 706, it is the first of such persons whose portability election (or specific non-election) will be respected. Thus, the reason to use the term “Portability Executor” is to encompass not only a court-appointed fiduciary but also any person who may make the portability election.

Special Provision for Estates in Excess of the Filing Threshold

In general, a 706 is not required unless the decedent’s gross estate for federal estate tax purposes, plus lifetime taxable gifts, exceeds the filing threshold of the decedent’s basic exclusion amount (currently $5.25 million for 2013). For those estates in which exceeding the filing threshold is a foregone conclusion, portability should not be mandated because it is highly likely that the decedent will use his or her entire lifetime exclusion amount. To allow such decedent’s executors to retain control over all of the pertinent tax elections, while still referencing portability, we suggest the following language:

(2) Estate Equal to or Greater Than the Filing Threshold. If, notwithstanding the provisions of § 2010(c)(4) of the Code and this [refer to section number of the marital agreement containing the portability provisions], a 706 on behalf of the Deceased Spouse is required to be filed pursuant to § 6018 of the Code, all decisions and elections with respect to such 706, including, but not limited to, whether a Portability Election is to be effected, shall be the sole responsibility of the Portability Executor.

Special Provisions for Estates Under the Filing Threshold

In situations in which (1) the less-wealthy spouse has an estate valued at less than the filing threshold and (2) the parties agree that the marital agreement should require a portability election, the following clauses may be considered on behalf of the less-wealthy spouse:

(3) Estate Less Than Filing Threshold.
(A) Reimbursement of 706 Costs. If, notwithstanding the provisions of § 2010(c)(4) of the Code and this [refer to section number of the marital agreement containing the portability provisions], a 706 on behalf of the Deceased Spouse would not be required to be filed other than to make the Portability Election, the Surviving Spouse shall reimburse the Deceased Spouse’s estate (the “Reimbursement”) for the reasonable costs incurred with effecting the Portability Election (including, but not limited to, all accounting, appraisal and legal costs incurred in preparing and filing the 706) (the “706 Costs”). For purposes of this subparagraph (A), all expenditures with respect to the preparation of the 706 shall be presumed to be reasonable, which may be rebutted by the Surviving Spouse.
(B) Timing and Recipients of Reimbursement. The Reimbursement shall be made within thirty (30) days of receipt by the Surviving Spouse of a written request for Reimbursement by the Portability Executor (the “Written Request”), and the Reimbursement shall be paid to the Deceased Spouse’s court-appointed fiduciaries of his or her estate, or, if no such estate proceeding has been commenced in any court, to the then-acting Trustees of the Deceased Spouse’s revocable trust, if any, or, if none, directly to such person or persons as are directly responsible for the payment of the 706 Costs (each a “706 Cost Payor” and together, the “706 Cost Payors”). For purposes of the preceding sentence, if the Reimbursement is payable to the 706 Cost Payors, the Written Request shall instruct the Deceased Spouse as to the identity and amount payable to each 706 Cost Payor, and, so as to verify such 706 Costs, the Written Request shall also include invoices or such other receipts or other indicia of payment as may be applicable.

From an estate tax standpoint, portability favors the wealthier spouse if the less-wealthy spouse dies first. The purpose of this provision is to provide certain protections for the less-wealthy spouse’s beneficiaries. The preparation of a 706 is not inexpensive, and the cost of such preparation is generally borne by the decedent’s estate. If a 706 is required to be filed solely for portability purposes, the deceased spouse’s beneficiaries would be responsible for the preparation costs without receiving any of the benefits. In this instance, because the surviving spouse is the only person benefiting from the 706 preparation, as a matter of equity, the surviving spouse should be the party to ultimately pay for expenses of such preparation.

In addition, a quid pro quo for a portability election is that under certain circumstances, the statute of limitations for the deceased spouse’s 706, which normally expires three years after the 706’s filing date, remains open for a limited purpose until the statute of limitations is closed on the surviving spouse’s 706. The limited purpose is solely to review the DSUE amount calculation. Thus, to the extent that the deceased spouse’s estate remains open for audit, the deceased spouse’s executor is required to retain adequate records that support the calculation of the DSUE amount. If the surviving spouse is significantly younger than his or her predeceased spouse, the retention of the records could be for a very long time. Thus, as a practical matter, we recommend that the deceased spouse’s executor consider (1) transferring copies of such supporting records to the surviving spouse soon after the 706 is filed and (2) entering into an agreement with the surviving spouse that the surviving spouse (and the surviving spouse’s estate, heirs, and successors) will be responsible for the documentation required to prove the DSUE amount. Because the DSUE amount benefits the surviving spouse, it makes sense for such surviving spouse to assume such responsibility. This issue is discussed further, below.

We include a reasonable cost presumption in the definition of “706 Costs” so that the portability executor can proceed with the 706 preparation without undue interference from the surviving spouse over costs, while safeguarding against abusive excessive spending.

Although the surviving spouse is responsible for the ultimate payment of the preparation costs, procedurally it may be difficult to have the surviving spouse actually pay for such costs directly. For this reason, subparagraph (A) sets forth a reimbursement provision. Subparagraph (B) then sets forth the procedures for the reimbursement by the deceased spouse’s estate or the persons in possession of the deceased spouse’s property in the event that no estate has been opened. Alternatively, the surviving spouse may agree to be directly responsible for the payment of such costs. If that occurs, the provision can be modified.

Conflict of Interest for the Surviving Spouse as to the Election

(4) Conflict of Interest as to Election. Should the Surviving Spouse also be the Portability Executor, and if a conflict of interest would be created if the Surviving Spouse effected the Portability Election, the Deceased Spouse shall provide in his or her Will for the ability of the Surviving Spouse to appoint such other Portability Executors as can properly effect the Portability Election.

This provision is intended to avoid any inadvertent family issues that may arise if the surviving spouse is also the portability executor. The drafter should take into consideration what may be considered to be a conflict of interest.

Provisions Mandating Cooperation by the Portability Executor as to the Surviving Spouse

(5) Cooperation by Portability Executor. If the Surviving Spouse is not the Portability Executor, the Deceased Spouse shall provide in his or her Will that his or her Executor shall communicate to the Surviving Spouse, as soon as is practicable after the Deceased Spouse’s death, the estimated amount of the DSUE Amount that is anticipated to be transferred to the Surviving Spouse. The Executor shall also provide to the Surviving Spouse a true and accurate copy of the 706 (and any amendments or supplemental forms thereto) that was filed with the Internal Revenue Service (the “IRS”).

This provision benefits the wealthier spouse by allowing him or her to use the less-wealthy spouse’s DSUE amount as soon as possible. In some instances, the deceased spouse’s executor (or, in this case, portability executor) may not have the best personal relationship with the surviving spouse. For this reason, if portability is to be used, the deceased spouse must acknowledge that he or she shall require his or her portability executor to provide an estimated DSUE amount to the surviving spouse as soon as is practicable.

Portability Executor’s Responsibilities

We include alternative provisions for the portability executor’s responsibilities. The first option mandates the delivery of the 706, and all information that served as a basis for the preparation of such 706, to the surviving spouse. The second option is an alternative provision in the event that the less-wealthy spouse has issues with providing such information to the wealthy spouse.

OPTION No. 1
(6) Portability Executor’s Responsibilities.
(A) Copy of 706 to Surviving Spouse. Upon effecting the Portability Election, the Portability Executor shall provide the Surviving Spouse with a complete copy of, (I) the Deceased Spouse’s 706 and, (II) any final adjustments as may be made to said 706 by the IRS, for use in tax filings in connection with the Surviving Spouse’s use of such DSUE Amount against the Surviving Spouse’s inter vivos gifts or testamentary transfers.
(B) Copies of Supporting Documentation. The Portability Executor shall also provide the Surviving Spouse with copies of any and all information and documentation that supports the filing of the 706 (as it may have been adjusted or supplemented). By way of example and not by way of limitation, for assets reported on the 706, the Portability Executor shall provide the Surviving Spouse with all statements of accounts from financial institutions, valuation reports by appraisers, as well as documents showing proof of ownership of assets (e.g., deeds). If assets are held in trust, the Portability Executor shall also provide the Surviving Spouse with a copy of the trust and all trust accountings available to the Portability Executor related to such trusts (that was used as the basis for filing the 706). With respect to deductions for debts, liabilities, administrative expenses, and/or other deductions, the Portability Executor shall provide the Surviving Spouse with any and all documentation supporting the existence of such liability, debt, expense and/or deduction.
(C) No Other Duties. Other than providing the copy of the 706 and supporting documentation, and any other information necessary to substantiate the DSUE Amount in the event of an audit of the 706, the Portability Executor shall have no additional obligations to the Surviving Spouse, the Surviving Spouse’s estate, heirs, beneficiaries and assigns (together, for purpose of this subparagraph (C), the “Surviving Spouse”); provided, however, that if the IRS requests additional information, beyond that requested herein, the Portability Executor (and/or the beneficiaries of any assets received from the Deceased Spouse) shall be responsible for delivering to the Surviving Spouse such additional information. If any additional costs are borne by the Portability Executor and/or the beneficiaries, the Surviving Spouse shall reimburse such additional costs. The additional costs shall be presumed to be reasonable, unless proven otherwise.

This provision contains provisions for both spouses—the wealthier spouse by providing the necessary backup documentation be provided to him or her to validate the DSUE amount and the less-wealthy spouse by relieving his or her portability executor from having any additional obligations for portability.

From a practical standpoint, as previously stated, the supporting documentation provides the surviving spouse with the requisite information and eliminates the need for any future requests from the deceased spouse’s heirs. It puts the burden on the surviving spouse to maintain and safeguard the information once he or she receives it, which seems to be a fair result.

We realize that in some cases there may be reticence to deliver financial information to the surviving spouse. Accordingly we provide a second option, as follows:

OPTION No. 2
(6) Portability Executor’s Responsibilities.
(A) Copy of 706 to Surviving Spouse. Upon effecting the Portability Election, the Portability Executor shall provide the Surviving Spouse with a complete copy of, (I) the Deceased Spouse’s 706 and, (II) any final adjustments as may be made to said 706 by the IRS, for use in tax filings in connection with the Surviving Spouse’s use of such DSUE Amount against the Surviving Spouse’s inter vivos gifts or testamentary transfers.
(B) Continuing Duties. The heirs, successors in interest and fiduciaries of the Deceased Spouse’s estate, including the Portability Executor (the “Successors”), shall have a continuing obligation to maintain and safeguard a copy of the 706, together with any other information necessary to substantiate the DSUE Amount reported on the 706 in the event of an audit. If the IRS requests additional information, beyond that requested herein, the Successors shall be responsible for delivering to the Surviving Spouse, the Surviving Spouse’s estate, heirs, beneficiaries and assigns (together, for purposes of this subparagraph (B) and subparagraph (C) of this paragraph (6), the “Surviving Spouse”), any such additional information requested by the IRS. If any additional costs are borne by the Successors, the Surviving Spouse shall reimburse such additional costs. The additional costs shall be presumed to be reasonable, unless proven otherwise.
(C) Continuing Liability—Remedy. In the event that the Successors are not able to produce any such documentation that is requested by the IRS, and, it can be determined that the DSUE Amount is adjusted in a negative manner, the Successors shall bear the burden of any costs, expenses, and any other damages that the Surviving Spouse may suffer as a result of such incident.

The attorneys representing the parties should convey to their clients the burden that the family will have to bear in the event that the information is needed to substantiate the DSUE amount in the event of an audit, which may be many years after the deceased spouse’s death. In addition, a fairly onerous remedy clause is added as subparagraph (C). This is just an example of a remedy for breach; we suggest that the parties negotiate a remedy that would make sense in the particular situation.

Portability Executor Defined

(7) “Portability Executor” Defined.
(A) Defined. For purposes of this [refer to the section number of the marital agreement containing the portability provisions], the “Portability Executor” shall be the following, in order of preference:
(I) Court Fiduciaries. The Deceased Spouse’s court- appointed fiduciaries of his or her estate (i.e., personal representative, executor, administrator, or such other term as used under the law governing the administration of the Deceased Spouse’s estate), or, if no such estate matter has been opened in any court,
(II) Trustees of Revocable Trust. The then-acting Trustees of the Deceased Spouse’s revocable trust, if any; or, if none,
(III) Code Definition of “Executor.” The “Executor” as defined pursuant to § 2203 of the Code, but such term shall not include the Surviving Spouse if at least one other person is in actual or constructive possession of any property of the Deceased Spouse.
(B) Spouse as Portability Executor. If the Surviving Spouse is the Portability Executor, such duties shall be subject to the provisions of paragraph (4) above.

The Regulations give preference to the court-appointed fiduciaries, because these are the individuals usually charged with the preparation and filing of a decedent’s 706. Absent a judicial estate proceeding, preference should next be given to the trustees of the decedent’s revocable trust. If no estate administration is judicially opened and no revocable trust is in existence, reliance is placed on the federal tax definition of “Executor” under IRC § 2203.

If the provisions of subparagraph (A)(III) apply and the portability executor is the Code definition of “Executor,” the surviving spouse is excluded from this category unless he or she is the only person receiving any of the deceased spouse’s property. This exclusion is in conformity with the provisions under most marital agreements whereby the parties waive all statutory rights to act as fiduciaries of the other’s estate. This provision, however, can be modified depending on an agreement between the parties.

On a related issue, although the parties can set forth the preferred hierarchy for the portability executor, the IRS is not bound by this hierarchy. Therefore, the possibility exists that, notwithstanding the marital agreement provisions, a portability election can be made when one was not intended or vice-versa. If the parties are concerned about this issue, perhaps an optional remedy provision could be added as subparagraph (C). Such remedy provisions should provide sufficient recourse against the breaching party so as to mitigate the potential for any such breach.

The American Bar Association’s Section of Real Property, Trust and Estate Law, through its Estate and Gift Tax Committee of the Income and Transfer Tax Planning Group, presented its comments to Treasury on the Proposed Regulations and Temporary Regulations Under Internal Revenue Code Sections 2001, 2010 and 2505, as submitted to the IRS on October 5, 2012. Lester B. Law, one of the authors of this article, was a principal draftsperson of the RPTE Comments. In the RPTE comments to Treasury regarding the new regulations, Treasury was asked to give further guidance on the effect that marital agreements would have on the Portability Election. We await their guidance.

Remedies for Failure to File Portability Election

Notwithstanding the detailed provisions, the potential always exists that the portability executor may fail to file a complete and properly prepared 706, to timely file the 706, or both. It is not clear under the Code or Regulations whether the portability executor has the authority under law to correct the error. These questions were directly asked of Treasury in the RPTE Comments. More importantly, query whether any provision can be added to prevent the portability executor from taking a contrarian view to the marital agreement and intentionally failing to make the portability election. Because not all scenarios are the same, this is a point best left to the drafting attorneys to determine the appropriate remedy based on the particular facts.

Conclusion

The more that portability is studied, the likelihood increases that more practitioners will realize that there is much more to portability than a simple election. Portability can create a valuable monetary asset that can and should be considered when drafting a marital agreement. The above provisions are representative of some of the issues currently considered about portability and how they can effectively be used in a marital agreement. By understanding the concept, the careful practitioner has an additional and effective negotiating tool when crafting a fair and equitable marital agreement and advising clients with ported DSUE amounts.

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