Yesterday, the IRS finally confirmed that it will recognize unnecessary QTIP elections on 706 returns filed to elect portability. This is good news and answers an ambiguity created by the final portability regulations that were issued last year.
A qualified terminable interest property (“QTIP”) election is an election under which a portion of a deceased spouse’s estate which would not otherwise be eligible for the marital deduction is treated as passing to the surviving spouse. The QTIP property is excluded from the estate of the deceased spouse and included in the estate of the surviving spouse. These are popular mechanisms for allowing mixed families to pass on wealth to specific sides of the family without completely bypassing the surviving spouse and while deferring significant estate tax on the first death. In recent years, QTIPs have become even more popular as portability elections have increased the estate tax exemption for the surviving spouse up to $10.9 Million and basis considerations have become more pronounced (a QTIP election also allows the elected property a step up in basis on the second death).
Prior to portability, Rev. Proc. 2001-38 provided the procedure for the IRS to disregard QTIP elections if they weren’t necessary to reduce federal estate tax. Basically, this treatment provided taxpayer relief to correct erroneous elections made by surviving spouses who didn’t benefit from the QTIP election. This remains a good tool for correcting mistakes on estate tax returns.
After portability, though, there are some circumstances in which a surviving spouse may want to make a QTIP election even if it doesn’t reduce federal estate tax (e.g. in order to achieve a step-up in basis on the assets subject to the election on the surviving spouse’s death). The temporary portability regulations issued in 2012 included an example of a surviving spouse doing just this; however, when the final regulations were released last year, that example was removed, leaving practitioners in the dark as to whether the IRS would recognize or ignore unnecessary QTIP elections.
Rev. Proc. 2016-49 issued yesterday clarifies that, where portability is elected and a QTIP election is made, even if that QTIP election does not reduce the federal estate tax liability, the IRS will recognize it.