Portability and the Availability of the New Jersey QTIP Election
This article appeared in the New Jersey Law Journal as part of a larger article entitled “Impact of Federal Estate and Gift Tax Issues on NJ Estate Tax” in their December 28, 2015 publication. The below is reprinted with permission from the New Jersey Law Journal.
In order to qualify for the unlimited marital deduction and defer New Jersey estate tax until the surviving spouse’s death, property passing to a surviving spouse in trust must meet certain requirements and a “QTIP” election must be made on a New Jersey estate tax return. Generally, under New Jersey law, an estate is bound by its choice regarding the federal QTIP election (or nonelection) (i.e., you cannot make inconsistent QTIP elections for federal and New Jersey purposes). However, it is unclear whether filing a federal estate tax return solely to elect portability (portability allows a surviving spouse to use the deceased spouse’s remaining federal exemption) and thus making no federal QTIP election, precludes an estate from making a separate QTIP election for New Jersey estate tax purposes. When determining how to proceed, there are two options to consider.
Option 1: File a federal return, elect portability and make a federal QTIP election, even though there are no federal estate tax implications.
In Rev. Proc. 2001-38, the IRS announced circumstances in which they “will disregard [a QTIP] election and treat it as null and void” if “the election was not necessary to reduce the estate tax liability to zero, based on values as finally determined for federal estate tax purposes.” The federal QTIP election will always be unnecessary to reduce federal estate tax liability on a federal estate tax return for an estate not subject to federal estate tax filed solely to elect portability. The preamble to the final portability regulations enacted on June 12, 2015 states that the Treasury Department and IRS are planning on issuing future guidance to clarify whether a QTIP election may be disregarded if an executor has also elected portability.
In other words, there is currently no clear guidance as to whether a QTIP election which is disregarded pursuant to Rev. Proc. 2001-38 by the IRS but nonetheless would save state estate taxes is valid for New Jersey purposes. Even if the QTIP election is treated as null and void for federal estate tax purposes, will it also be treated as null and void for New Jersey purposes? Again, there is no clear answer to this question. New Jersey could determine that, because the federal QTIP election was actually made (although disregarded for federal purposes), that it would be valid, but to date, there is no official guidance on this issue. See Letter dated January 31, 2011, from Fred M. Wagner III, Assistant Chief, Individual Audit Branch, New Jersey Division of Taxation, to Robert D. Borteck, reprinted in Practical Drafting at 10462 (April 2011) (the “Wagner Letter”), outlining the state’s position concerning QTIP elections for decedents who died in 2010.
The risk here is that the IRS may argue that the QTIP election was intentionally made and will not disregard the QTIP election for federal purposes, and will seek to tax the property subject to the election at the surviving spouse’s death, even if such property otherwise would have been sheltered from the federal estate tax.
Option 2: File a federal return that just elects portability and make a separate New Jersey QTIP election.
Generally, if an estate files a federal estate tax return, the estate is bound by its choice regarding the federal QTIP election (or nonelection) and is precluded from making a separate QTIP election for New Jersey estate tax purposes. If no federal estate tax return is filed, the executor can make a separate state QTIP election. However, at least one state has taken the position that if a federal estate tax return is filed, even if only to elect portability, the federal QTIP election or nonelection will be binding for state estate tax purposes (the State of New York took this position in NY Tech. Mem. TSB-M-11(9)M).
It may be possible to take the position that, because an estate is not required to file a federal return electing portability, the estate should not be bound by its nonelection on a federal return for New Jersey estate tax purposes, although this position appears contrary to current Division of Taxation policy. See the Wagner Letter. Interestingly, New Jersey has allowed civil union partners to make a separate New Jersey QTIP election for New Jersey purposes, even though they were expressly precluded from doing so for federal purposes. In addition, in Estate of Stevenson v. Director, Division of Taxation, 23 N.J. Tax 583 (2008), the Court held the New Jersey estate tax is a fiction whereby circumstances should be viewed as they would have been in 2001, meaning that there is an argument that a QTIP election would be permitted for estates over $675,000 because the exemption amounts are aligned.
The risk here is that filing a federal return to elect portability will render the New Jersey QTIP election unavailable which will cause an immediate estate tax consequence on the first death.
Although there is no clear guidance, it appears that Option 1 may be the safest approach. Practitioners have reported receiving closing letters from the State of New Jersey when making a federal QTIP election on a return filed solely to elect portability and then making a corresponding election on a New Jersey return. Clients must be advised of the real risks in connection with both approaches and that neither approach may work as intended.