Portability – Examination of a Predeceased Spouse’s Estate Tax Return

In a recent case that is a cautionary tale to preparers of federal estate tax returns, the Tax Court held that the IRS was permitted to examine the estate tax return of the first spouse to die in determining the deceased spousal unused exclusion amount (DSUE) available to the estate of the surviving spouse.  The result was an increase to the federal estate tax in the estate of the second spouse.

A husband died in 2012 and his estate reported his DSUE on form 706, the federal estate tax return, and elected portability of the DSUE to the surviving spouse.  The IRS sent the husband’s estate a federal estate tax closing letter reporting the return was accepted as filed.  When the wife died in 2013, her estate claimed the DSUE reported by the husband’s estate.  As part of the examination of the wife’s federal estate tax return, the IRS also examined the 706 filed by the husband’s estate.  Without determining a deficiency against the husband’s estate, the IRS reduced the amount of the husband’s DSUE by the amount of taxable gifts given by husband during his life.  This reduction in the DSUE reduced the total exclusion available in the wife’s estate and resulted in an increase of the estate tax.

Several holdings by the court are noteworthy:

1.  The IRS may examine the estate tax return of a predeceased spouse to determine the correct DSUE amount.  I.R.C. § 2010(c)(5)(B).

2.  A letter stating the estate tax return of a predeceased spouse has been accepted as filed is not a closing agreement under I.R.C. § 7121, nor does it estop the IRS from examining the return of the predeceased spouse.

3.  An examination of the estate tax return of a predeceased spouse in which the IRS reviews records in its possession and asserts no additional tax is not a second examination within the meaning of I.R.C. § 7605(b), nor can the estate of the later deceased spouse challenge whether such examination is improper—only the examined party can seek protection from a second examination under I.R.C. § 7605(b).

4.  The period of limitations on assessment of tax for the estate of the predeceased spouse is not implicated if the IRS does not determine an estate tax deficiency in the estate of the predeceased spouse.

Estate of Sower v. Commissioner, 149 T.C. No. 11 (9/11/2017)