I cannot imagine we will ever see another year like 2010. There is no estate tax, that is, there is no tax on the transfer of wealth at death. For thousands of American families, this has resulted in tax savings that would have been unimaginable only a few years ago.
Some of these families have been highlighted by the popular media. Yankee owner George Steinbrenner, real estate developer Walter Shorenstein, energy magnate Dan Duncan, and Albemarle’s John Kluge, billionaires all, died in this calendar year. By a remarkable stroke of good fortune, the federal tax laws permitted them to pass on their lifetime of accumulated wealth to their families without paying any transfer tax.
Surely there are thousands of other unremarked-upon millionaires who have died or will die in 2010, and who were nimble enough in their estate tax planning to take advantage of this one-year-only estate tax holiday.
The stage was set for all this back in 2001, when President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act (“EGTRRA”). The per-person estate tax exemption was raised in steps from $1.0 million in 2001 to $3.5 million in 2009, culminating in the complete repeal of the federal estate tax for one year only – 2010 – and a return to 2001 levels of taxation on January 1, 2011.
But few (if any) estate and gift tax attorneys ever thought 2010 would arrive without Congress making some legislative fix to prevent a one-year-only repeal. Despite the conventional wisdom that it would never happen, on January 1, 2010, the estate tax was repealed. It called to mind British Prime Minister Lord Melbourne’s remark, that “what all the wise men promised has not happened, and what all the damned fools predicted has come to pass.”
While estate tax repeal is a taxpayer bonanza for some, it contains a dark underside for everyone who inherits assets from a person who died in 2010. I am referring to the change in the laws relating to the “tax basis” of assets passing from a decedent’s estate to the decedent’s beneficiaries. These rules prior to estate tax repeal were explained by Robert J. Kolasa, an Illinois estate planning attorney.
[W]hen a taxpayer sells an asset, there is generally an income tax on the difference between the sales proceeds and ‘cost basis’ (what was paid for the asset). Under the pre-2010 rules,… when a person died the cost basis was generally increased (‘stepped up’) to its value on date of death. When the asset is later sold, only the difference between the sales proceeds and date of death value would generally be taxed.
Assets inherited in 2010 no longer qualify for automatic “step up” to the fair market value on the date of the decedent’s death. Under Section 1022 of the Internal Revenue Code, the beneficiary takes the asset with a basis equal to the lesser of (i) the decedent’s basis or (ii) the fair market value of the asset on the date of the decedent’s death. The basis can then be increased under two possible basis adjustments.
In the first basis adjustment, the decedent’s executor may allocate up to $1.3 million to increase the basis of an asset passing to any beneficiary to its fair market value on the date of the decedent’s death. The second adjustment allows an executor to allocate an additional $3 million in basis to assets passing to a surviving spouse, outright or in trust. Of course these allocation rules are subject to many limitations.
1. The basis increase is limited to the property’s fair market value. If the asset is publicly traded stock, the fair market value is easily determined. But what if the asset is a closely held corporation or investment real estate? Even though there may be no estate tax return to be filed, the executor will still have to hire appraisers and provide the information to the IRS.
2. The basis increase must be applied to assets owned by the decedent at death. Thus, for example, property held in a QTIP trust for the decedent’s benefit will not qualify for the basis adjustment.
3. Certain assets are specifically excluded from basis adjustment, including proceeds from a qualified retirement plan account (e.g., IRA or 401-k plans) and assets acquired by the decedent by gift within three years of the decedent’s death.
There is no doubt these new rules will greatly complicate the administration of a decedent’s estates. I have already had a number of clients inform me of the position certain brokerage houses are taking with respect to reporting the basis of the publicly-traded stock acquired from a decedent who died in 2010 on the monthly brokerage statement. They insist upon listing the lower of (i) the decedent’s basis on the date of death or (ii) the fair market value of the asset on the date of death.
I suspect they will correct the basis upon presentation of an IRS tax form reflecting the executor’s allocation under the rules set forth above. But such a form does not yet exist. Apparently, the IRS never expected estate tax repeal either.