At the Intersection of Portability and Blended Families!


Executive Summary: In this case, out of the Oklahoma Supreme Court, the Oklahoma Supreme Court affirmed a trial court’s order forcing the executor of a deceased spouse to file a federal estate tax return and make a portability election.

Facts: Anne died intestate on January 22, 2016, survived by her husband, C.A., and two children from a prior marriage. Anne and C.A. had married in 2006 and had signed a prenuptial agreement whereby each waived all interests in the other’s estates. There was no mention of portability in the prenuptial agreement, probably since portability wasn’t added to the law until 2010.

At first, Anne’s son, Robert, probated a 1995 will and was named executor. C.A. moved to be named administrator, alleging that since Anne died intestate, having revoked the 1995 will, and C.A. was then named administrator, until they provided the court with the prenuptial agreement, wherein C.A.’s waiver of the right to serve as administrator came to light, after which Robert was named administrator.

On August 10, 2016, C.A. filed an Application to Compel Administrator to Timely Prepare and File a Federal Estate Tax Return for Purposes of Irrevocably Electing Portability of Decedent’s Deceased Spousal Unused Exclusion Amount (Application).

On November 8, 2016, the district court entered its order effectively granting C.A.’s Application. The district court, non-exhaustively: 1) denied C.A.’s request for appointment of a special administrator for purposes of filing an estate tax return for Anne; 2) ordered Robert to provide C.A. with a list of the records necessary to prepare the estate tax return and ordered C.A. to provide the records; 3) ordered C.A. to produce to Robert a detailed inventory of the personal property of Anne in his possession and make it available for pickup; 4) ordered, if a DSUE Amount is available, that Robert shall timely file an estate tax return electing portability of the DSUE Amount and allow C.A. 60 days to review the return and documentation prior to filing; and 5) ordered C.A. to pay for the filing of the return if a DSUE Amount is available.

Robert filed a fast track appeal to the Oklahoma Supreme Court, which granted that motion on December 16, 2016. Robert raised several points of error on appeal, including: 1) the district court lacked subject matter jurisdiction; 2) its order concerning the DSUE is preempted by federal law; 3) the trial court failed to properly consider the antenuptial agreement and therefore erroneously determined C.A. had standing; 4) the district court’s order violates the terms of the antenuptial agreement.

On appeal Robert asserted that he is the appointed executor within the meaning of the relevant federal law. Accordingly, he argued on appeal that, pursuant to IRC Sec. 2010 and the applicable regulations, the decision to elect portability of the DSUE Amount is discretionary and entirely his to make. Robert further argued that the district court therefore had no subject matter jurisdiction over the matter, and that its order compelling him to make the election is directly contrary to federal law and any state law grounds on which it might be based are defeated by the preemption doctrine.

The Oklahoma Supreme Court didn’t agree with Robert. The Oklahoma Supreme Court concluded that the district court had subject matter jurisdiction and that Robert’s claim was for complete preemption, which the Court noted was rarely granted. The Oklahoma Supreme Court observed:

[C.A.’s] claims concerning the DSUE are rooted in Oklahoma law concerning the fiduciary obligations owed by estate administrators to potential beneficiaries of the estate. There is no indication in the federal law provisions concerning the DSUE that the Congress intended to leave no room for state law claims relating to the duties of the estate administrator, even if those duties involve a federal matter such as the election of the DSUE. Indeed, the IRS itself acknowledged that the question of what state law actions might bring a surviving spouse within the definition of executor pursuant to 26 U.S.C.A. § 2203 are outside the scope of its regulations, implicitly acknowledging the interplay between state laws concerning probate and estate distribution and the federal estate tax provisions. The complete preemption doctrine is inapplicable here and does not deprive the district court of subject matter jurisdiction in this cause.

 

 It is the conclusion of this Court that the district court’s order compelling Lee to file an estate tax return and elect portability is within the district court’s subject matter jurisdiction and is not preempted by federal law.

 The Oklahoma Supreme Court continued:

[C.A.] has an obvious interest in the portability of the DSUE. The determinative question, then, is not whether the antenuptial agreement between [C.A.] and [Anne] bars him from being a legal heir, but whether the agreement bars him from claiming any interest in the portability of the DSUE.

 [C.A.’s] interest in the DSUE is not barred by the antenuptial agreement he entered into with Decedent.

Given the above principles, the antenuptial agreement does not bar [C.A.’s] interest in the DSUE. The portable DSUE is not simple property acquired by one party over the course of the marriage according to existing laws in effect when the agreement was made. Itis an interest created by the federal tax code that was an impossibility at the time the antenuptial agreement between [C.A.] and [Anne] was created. The antenuptial agreement was entered into on May 24, 2006, and portability of the DSUE became an option under the federal tax code for the first time with the passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Pub. L. No. 111-312, § 303, 124 Stat. 3296 (2010). [C.A.] and [Anne] clearly intended a comprehensive waiver of their marital rights under the law as it existed at the time, and included reference to specific statutory provisions where necessary. However, the agreement is silent as to portability because the change in law was unforeseeable to the parties when the contract was made. Accordingly, the district court was correct in implicitly determining that the antenuptial agreement did not bar [C.A.] from asserting an interest in portability of the DSUE.

The Oklahoma Supreme Court affirmed the trial court, noting:

[Robert] argues that since the DSUE is valuable only to [C.A.], while at the same time being an estate asset under Lee’s complete control, he should be allowed to demand consideration from [C.A.] in exchange for making the election. [Robert] further argues that pursuant to 26 U.S.C.A. § 201o(c)(5), electing portability of the DSUE will extend the audit window for Decedent’s estate considerably. While 26 U.S.C.A. § 2010 requires the administrator to make the election to allow portability of the DSUE, the only person with an interest in and ability to use the DSUE, if it exists, is the surviving spouse. If the election is not made through the timely filing of an estate tax return, then it is lost.

U.S.C.A. § 201o(c)(5)(A). [C.A.] has also agreed to pay any costs associated with preparing the necessary return.

 The district court, after hearing expert testimony and considering the evidence, evidently determined that any risk to the estate was outweighed by [Robert’s] fiduciary obligation to preserve the assets of the estate and safeguard [C.A.’s] interest in the DSUE. We agree, and determine the district court did not err by requiring [Robert] to file a federal estate tax return and elect portability of the DSUE. The district court’s order was not contrary to the clear weight of the evidence or applicable governing law, and is therefore affirmed.

 Comments: The Oklahoma Supreme Court docketed and decided this case in about 39 days, which is very fast for such a court to move. It’s uncorrected (as of yet) opinion reflects that speed, at several points getting the parties’ arguments wrongly associated with a party, i.e., reversing the arguments that each party made. Given that Anne died on January 22, 2016, the Oklahoma Supreme Court’s January 24, 2017 ruling gives Robert, as administrator, about three months to file the Form 706, assuming that Robert timely filed for the six month extension.

There apparently were some conflicts of interest allegations in this case that the trial court deferred, but the Oklahoma Supreme Court’s opinion didn’t shed any light on them. Inquiring minds want to know!

This decision seems to be a correct affirmation of what apparently was a well-reasoned trial court decision. I wish that I had seen the trial court’s opinion, because it appears from the description of the trial court’s order in the Oklahoma Supreme Court’s opinion that the case was well pled and well-lawyered in that all of the issues seem to have been addressed. The trial court’s order also seems to have been very even-handed. For example, the trial court required C.A., as surviving spouse, to pay for the preparation and filing of the federal estate tax return.

One could quibble with the courts’ conclusions that the prenuptial agreement’s waiver of estate rights, which obviously predated portability as a possibility, didn’t cover portability, as well as the conclusion that the surviving spouse after the prenuptial agreement waiver had standing in the probate court. However, in light of this decision, it is imperative that estate planners revisit all pre-portability (2010) marriage contracts to permit the spouses to now consider portability. However, caution is in order on several scores. Firstly, one may be opening Pandora’s Box to revisit the entire agreement, which one spouse often doesn’t want to do. Secondly, one must consider applicable state law. Some states, e.g., Ohio, simply don’t permit amendment of marriage contracts.

An executor who is a child of a prior marriage, as was the case here, may choose not to incur the expense of filing an estate tax return and the risk of audit of the DSUE Amount solely to make the portability election for the sole benefit of surviving step-parent spouse, with some risk to the first estate. In this case, Anne died intestate, and, because of the prenuptial agreement, C.A. had no interest in her estate, including service as administrator, which he waived in the prenuptial agreement. However, it isn’t inconceivable that some of Anne’s interest in property nevertheless passed to C.A. via survivorship or beneficiary designation, all of which would have to be listed on the federal estate tax return. However, given the prenuptial agreement and that Anne died intestate, it is doubtful that there is any QTIPable property in her estate.

The use of portability with QTIP trust planning, which the IRS now acknowledges in Rev. Proc. 2016-49 can happen (essentially modifying Rev. Proc. 2001-38), in subsequent marriages where the QTIP trust property is going to pass to the descendants of the first spouse to die could visit hardship and federal estate tax exposure to those descendants where the surviving spouse used some or all of the deceased spouse’s DSUE Amount during his or her overlife and didn’t waive reimbursement of the federal estate tax on the QTIP trust, which few spouses in multiple marriage situations ordinarily do. The spouses could agree during lifetime to permit the surviving spouse to have the use of any DSUE Amount of the first spouse to die via a QTIP election in return for an agreement that the surviving spouse would waive the right of reimbursement for tax due as a result of the inclusion of the QTIP trust in the surviving spouse’s estate (or at least for that portion of the QTIP trust equal to the DSUE Amount).

I predicted some time back that there’d be boatloads of state court litigation over this issue, primarily out of blended families. The Congress and the IRS could have saved us a lot of time and trouble by giving the surviving spouse a right to make the portability election, but they didn’t, and I’m glad that they didn’t because that election can have adverse effects on the estate of the first spouse to die. Given the potential value of the DSUE Amount to whichever of the spouses survive, couples should provide relative to portability. In blended families, it is important that the couple have a frank and honest discussion about portability. The couple should provide instructions relative to it in their estate planning documents and prenuptial agreements. What should that agreement look like?

The first of the couple to die would require his or her executor to timely prepare and file a federal estate tax return and make the portability election. The surviving spouse would agree to pay all of the costs of preparing and filing the return to the satisfaction of the executor, who would agree to cooperate and provide all information concerning the deceased spouse’s assets and liabilities.

The surviving spouse would agree to indemnify, defend and hold the executor of the estate of the first spouse to die harmless from and against any and all taxes, penalties and interest arising out of making the portability election. If a QTIP election is made on the estate tax return of the first spouse to die, the surviving spouse would agree to waive reimbursement of the federal estate tax attributable to inclusion of the DSUE Amount in the surviving spouse’s estate in his or her estate planning documents and agree to pay that federal estate tax, together with penalties and interest, if the waiver is ineffective for any reason.

It’s doubtful that we’ve seen the last of these cases; as I predicted, I think that they’re just beginning. I predict that there will be different conclusions in different courts on this issue. About the best we can all do is properly advise our clients to try to avoid this mess by proactively planning for it, and stay tuned for more!

Cites: In The Matter Of The Estate Of Vose, 2017 0K 3, Case Number: 115424 (Okla. January 24, 2017); IRC Sec. 2010.

About lpaulhoodjr

I am an inactive lawyer who practiced almost 20 years as a tax and estate planning lawyer. Today, I am the Director of Planned Giving for The University of Toledo Foundation. I am the co-author of four books, the sole author of another book and a frequent speaker and writer on estate planning, planned giving and business valuation.
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