Estate Tax Portability: Tax Court Emphasizes Importance of Proper Filing

Summary — In Estate of Rowland v. Commissioner, the Tax Court held that estate tax returns filed solely to elect portability must still be complete and properly prepared. Even when no estate tax is owed, missing asset-level information can invalidate the portability election, resulting in the loss of valuable unused estate tax exemption for the surviving spouse.

The federal estate tax portability rules allow a surviving spouse to use a deceased spouse’s unused estate tax exclusion amount (the “DSUE amount”), potentially doubling the amount that can pass free of estate tax at the surviving spouse’s death. Because most estates fall below the filing threshold, executors often file an estate tax return solely to elect portability for the benefit of the surviving spouse. A recent Tax Court decision, Estate of Rowland v. Commissioner, serves as an important reminder that, even when filed solely to elect portability, estate tax returns must be prepared completely and carefully.

Portability and Filing Requirements

For a surviving spouse to claim their deceased spouse’s DSUE amount, the executor of the deceased spouse’s estate must have timely filed an estate tax return making a valid portability election. Although Treasury Regulations provide certain relaxed reporting rules for returns filed solely to elect portability, those rules are limited in context and do not excuse omissions that prevent the IRS from verifying the DSUE amount.

The Rowland Case

In Rowland, the decedent’s estate was below the federal estate tax filing threshold and was not required to file an estate tax return. The executor filed a return to elect portability of the DSUE amount for the surviving spouse. Although the return was filed late, it was submitted within a two-year relief period then authorized by the IRS. That relief, however, only applied if the return was “complete and properly prepared” in accordance with applicable Treasury Regulations.

The return did not report fair market values for the estate’s individual assets. Instead, the executor reported a generalized estimate of the estate’s total value, relying on the relaxed reporting rules applicable only to very specific bequests.

Because the decedent’s estate plan made percentage-based distributions among multiple beneficiaries — including the surviving spouse, a charity, and descendants — individual asset values were necessary to determine what each beneficiary received and to calculate the remaining estate tax exemption. Without that information, the IRS concluded that the estate had not filed a complete and properly prepared return and disallowed the portability election.

The Court’s Ruling

The Tax Court agreed with the IRS. The court explained that the Treasury Regulations permit relaxed reporting on estate tax returns filed solely to elect portability only for property passing to a surviving spouse or a qualifying charity, and only in limited circumstances.

In Rowland, however, the decedent’s return failed to distinguish between property passing to the surviving spouse and the charitable foundation and assets passing to non-qualifying beneficiaries. In other words, the taxpayer improperly applied the relaxed valuation rules across all of the estate’s assets. The court further explained that the relaxed reporting rules were unavailable in any event because the decedent’s estate plan made percentage-based distributions to the surviving spouse and a charitable foundation, with the remainder passing to the decedent’s grandchildren. Under that structure, the value of the marital and charitable gifts had to be determined to calculate what remained for the grandchildren.

Without knowing the value of that remainder, the IRS could not determine the decedent’s taxable estate or verify the amount of unused estate tax exemption available for portability. Because the estate failed to provide specific asset-level valuations, the return was not complete and properly prepared, and the portability election was completely invalidated.

Why This Matters

Rowland underscores that a portability election is not a mere formality. Even when no estate tax is due at the death of the first spouse, an estate tax return filed to elect portability must be complete and accurate, or else the election may be invalidated.

The risk is greatest when an estate plan includes percentage-based distributions or beneficiaries other than a surviving spouse or charity, because asset values may be essential to determining whether portability is available at all. In Rowland, deficiencies in the portability return resulted in the disallowance of approximately $3.7 million of unused estate tax exemption, which could have saved the surviving spouse’s estate almost $1.5 million in estate taxes.

Ultimately, executors and families should approach portability elections with the same care and diligence as they would any estate tax filing and consult experienced counsel to help avoid costly mistakes.