The concept of “portability” was introduced into the Internal Revenue Code (“IRC”) pursuant to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. Portability allows a surviving spouse to apply an unused portion of a deceased spouse’s estate tax exclusion amount to his or her own estate tax liability.
In a case of first impression, the U. S. Tax Court in Estate of Sower v. Commissioner of Internal Revenue, 149 T.C. No. 11 held that upon the death of a surviving spouse, the IRS may reexamine the estate tax return of the predeceased spouse to determine the correct deceased spousal unused exclusion (“DSUE”) amount, regardless of whether the period of limitations on assessment has expired for that return.
Frank Sower died in 2012, survived by his wife Minnie Sower. The executor of Frank’s estate filed an estate tax return for Frank, reporting a DSUE amount of approximately $1.26 million, and elected portability of the DSUE amount. After processing Frank’s estate tax return, the IRS issued a closing letter to the executor of Frank’s estate indicating that the estate tax return had been accepted as filed.
Minnie Sower died in 2013. The executor of Minnie’s estate filed an estate tax return, claiming the DSUE amount reported on Frank’s previously filed estate tax return. The IRS examined Minnie’s estate tax return, and as part of this examination, the IRS also examined Frank’s estate tax return. After examining the returns, the IRS determined that Frank’s estate tax return failed to report several taxable gifts that Frank had made during his lifetime. Thus, the IRS reduced the DSUE amount by the value of these unreported taxable gifts. As a result of this reduction in the DSUE amount (and adjustments to Minnie’s taxable estate based on her own unreported lifetime taxable gifts), the IRS determined an estate tax deficiency of approximately $788,000 against Minnie’s estate.
The executor of Minnie’s estate petitioned the Tax Court and advanced several arguments as to why the IRS should be prohibited from considering Frank’s estate tax return for the purpose of adjusting the DSUE amount available to Minnie’s estate, including the following:
- The IRS closing letter issued to the executor of Frank’s estate should be treated as a closing agreement pursuant to IRC § 7121;
- The IRS conducted an impermissible second examination of Frank’s estate tax return; and
- IRC § 2010(c)(5)(B) is “unconstitutional for want of due process of law in that there is no statute of limitations.”
The IRS issued a closing letter to the executor of Frank’s estate
With respect to the closing agreement argument advanced by the petitioner, the court noted that IRC § 7121(a) authorizes the IRS to enter into written closing agreements “with any person relating to the liability of such person” and such agreements are final and conclusive. However, the court held that because there was no evidence of an agreement (negotiations, offer and acceptance, etc.) between Frank’s estate and the IRS, the estate tax closing letter did not constitute a closing agreement under IRC § 7121(a).
The IRS conducted an impermissible second examination of Frank’s estate tax return
Regarding the petitioner’s argument that the IRS is prohibited from conducting a second examination of Frank’s estate tax return, the court explained that IRC § 7605(b) does prohibit the IRS from conducting an impermissible second examination of a taxpayer’s return. However, the Tax Court has previously held that the IRS does not conduct a second examination if the IRS does not obtain any new information.
Here, the court held that the IRS did not request or obtain any new information from Frank’s estate, and thus, Frank’s estate tax return was not subject to a second examination. Further, the court went on to explain that even if the IRS had obtained new information and conducted a second examination of Frank’s estate tax return, this would not have changed the outcome because Minnie’s estate is the party claiming protection against a second examination. If Frank’s estate tax return was subject to a second examination, the IRS would have violated IRC § 7605(b) with respect to Frank’s estate, but not with respect to Minnie’s estate.
IRC § 2010(c)(5)(B) is “unconstitutional for want of due process of law
Lastly, the court addressed the due process argument advanced by the petitioner.
IRC § 2010(c)(5)(B) provides the following:
Notwithstanding any period of limitation in section 6501, after the time has expired under section 6501 within which a tax may be assessed under chapter 11 or 12 with respect to a deceased spousal unused exclusion amount, the Secretary may examine a return of the deceased spouse to make determinations with respect to such amount for purposes of carrying out this subsection.
The court held that IRC § 2010(c)(5)(B) does not violate due process because while the IRS may examine the return of the predeceased spouse outside of the period of limitations, the IRS is not granted the power to assess any tax against the estate of the predeceased spouse outside of the period of limitations. Here, the additional estate tax was assessed against Minnie’s estate (the surviving spouse), and no additional tax was assessed against Minnie’s predeceased spouse.