New York Estates: QTIP or Portability Election?

Married individuals in New York with a gross estate over the New York applicable exclusion amount but under the federal applicable exclusion amount may be in a QTIP/Portability dilemma.

A Qualified Terminal Interest Property (“QTIP”) election, allows estates to qualify for the marital deduction when property is not transferred outright to the surviving spouse. Instead, it is transferred in trust, a QTIP trust – otherwise known as a marital deduction trust.

NYS Department of Taxation and Finance recently issued a Technical Memorandum restating existing law that when a QTIP election is made on a federal estate tax return, the QTIP election is binding for New York estate tax purposes. If a federal estate tax return is required to be filed and a QTIP election is not made, no QTIP election can be made for New York estate tax purposes. If, however, a federal estate tax return is not required to be filed, only then can a separate election be made for New York purposes similarly reflected on a pro forma federal return. (TSB-M-14(6)M (Aug. 25, 2014)).

The problem arises when we consider portability. Available only for federal estate tax purposes, portability was made permanent by the American Taxpayer Relief Act of 2012, allowing an estate of a predeceased spouse to pass its unused federal exclusion to the surviving spouse.  Portability is available only if it is affirmatively elected on a timely filed federal estate tax return. (IRC § 2010(c)(5)(A)).

In New York, it is problematic when a predeceased spouse’s taxable estate is smaller than the federal applicable exclusion amount – creating a situation where portability might be beneficial – but greater than the New York applicable exclusion amount – where a QTIP election might be beneficial. In such a case, a federal return must be filed to make the desired portability election and the estate will be bound by any QTIP election it makes on the federal return.

Why is this problematic? The IRS has stated that in the case of a QTIP election “where the election was not necessary to reduce the estate tax liability to zero…the [IRS] will disregard the election and treat it as null and void.” (Rev. Proc. 2001-38). Thus, in the situation above, the estate faces a catch-22. The estate must file a federal return to elect portability but any QTIP election made therein will be treated as “null and void.” Importantly, under New York law a separate QTIP election is not available.

Bottom line: this is a bizarre result leaving practitioners and clients troubled and skeptical. The IRS acknowledged this issue and placed it on the 2013-2014 Priority Guidance Plan but it remains to be addressed. It is now on the 2014-2015 Priority Guidance Plan, dated Aug. 26, 2014. Stay tuned.

-Josie Colomar