The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act), P.L. 111-312, was signed by President Barack Obama on December 17, 2010, and revised tax law for estates of decedents dying in 2010, 2011, or 2012. The pre-2001 rules will be reinstated for deaths starting in 2013 unless Congress acts again before 2013. The new rules apply for 2010 unless an executor elects to use prior law. This election is made on Form 8939, Allocation of Increase in Basis for Property Acquired from a Decedent. However, the IRS has not yet released a final version of Form 8939. Elections for 2010 decedents can be made at a time not less than nine months from December 17, 2010, so estates of decedents dying in early 2010 can still be made timely.
The 2010 Tax Relief Act provides a $5 million estate tax exemption (indexed for inflation after 2011), a step-up in basis to market value, a top rate of 35% on taxable transfers (Sec. 2001(c), as amended by the 2010 Tax Relief Act, §302(a)(2)), and portability of unused exemptions between spouses for 2011 and 2012. Portability allows the estate of the second spouse to die to claim the unused exemption not claimed by the estate of the first spouse to die if the executor of the first-to-die spouse makes a timely election on the estate tax return of the first-to-die spouse. This effectively creates a $10 million exemption for married couples.
The 2010 Tax Relief Act also increased the lifetime gift tax exemption to $5 million starting in 2011. The generation-skipping transfer (GST) tax was reinstated, but the rate is zero for transfers in 2010, with a $1 million exemption. The GST tax is reunified with the gift tax ($5 million exemption) for 2011 and 2012.
The election in the 2010 Tax Relief Act to apply prior law may create traps for executors and affect beneficiaries, so understanding the election and preparing scenarios for 2010 deaths using old and new law is critical post-death planning. Some commentators believe that executors (and tax return preparers) may face litigation if the election decision adversely affects some classes of beneficiaries and their interests are not fully considered (and possibly should even compensate those heirs hit with higher income taxes that will result if an election is made to use the old law modified carryover basis instead of the new law step-up to fair market value (FMV)).
The old law was the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), P.L. 107-16, which repealed the estate tax for decedents dying after December 31, 2009, but before January 1, 2011. For 2010, estates were allowed to pay no estate tax, but assets in the estate did not receive a step-up in basis to FMV at the date of death or alternate valuation date (Sec. 1022, as amended by EGTRRA, §542). The basis in heirs’ assets was to be determined under the modified carryover basis rules under Sec. 1022, treating property as acquired by gift, with basis being the lower of the decedent’s adjusted basis at date of death or FMV at death. Basis was subject to a special allocation of $1,300,000 (increased for unrealized losses and unused capital losses and net operating loss carryovers not exceeding FMV at death) plus an additional allocation of $3 million if distributed to a spouse (see also Joint Committee on Taxation, Technical Explanation of the Revenue Provisions Contained in the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” (JCX-55-10), p. 42 (December 10, 2010)).
We do not yet know whether Congress will apply pre-EGTRRA rules ($1 million exemption, 55% rate) for deaths after 2012 or make further changes before 2013. This makes planning highly complex and perhaps further complicates it if there is a first-to-die spouse in 2010. However, if the increase to a $5 million exemption and portability between spouses of the exemption becomes permanent, fewer people may need estate planning and may rely on the exemptions to cover their needs.
For deaths in 2010, the new rules apply unless an executor elects to have the EGTRRA rules apply, which provide for no estate tax and modified carryover basis. The due date for filing an estate tax return, paying the estate tax, and making any disclaimer of assets will be not earlier than nine months after December 17, 2010 (2010 Tax Relief Act, §301(d)(1); Sec. 6075). Therefore, executors may be called upon to justify their choice of whether to use the old rules or the new rules by some classes of heirs, leading to possible litigation if the parties are negatively affected. The election will in some cases result in a lower estate tax but create income tax burdens for selected beneficiaries by using modified carryover basis.
For example, depending on the terms of the will, estate taxes may be paid from the residuary estate and not burden specific bequests. If an election is made to use the old rules and pay no estate tax, which benefits residuary beneficiaries, while giving up a step-up in basis, that election may negatively affect beneficiaries of specific bequests who get a lower basis in assets received and higher income tax if the asset is sold.
Similar issues may arise when the executor is called upon to make the special basis adjustments and one group of beneficiaries is favored over another. Will those affected have a cause against the executor and other tax planners? If the estate tax was to be paid by residuary beneficiaries, has the recipient or a specific beneficiary been injured? Will executors who are also beneficiaries have a conflict of interest when deciding whether to elect the old law or the new law?
There are other examples where the interests of parties could be affected by making the election. If the decedent is a first-to-die spouse with a well-written document leaving assets to a bypass trust and the surviving spouse, no immediate estate tax is due. What if the estate is asset rich, cash poor, but valued over $10 million? If the surviving spouse wants to convert assets to cash to pay estate tax upon his or her death, a step-up in basis may in some cases be the best choice to allow asset sales with little or no income tax while providing cash to pay the second-to-die estate tax. The tax planner would have to run the numbers using various scenarios.
Some commentators have suggested that executors air the issue with beneficiaries and even request a court determination before deciding whether to make the election. Accountants advising executors or preparing estate tax filings might well request some indemnification or make clear that this decision is made by the estate with an understanding of the impact on various classes of beneficiaries.
Valrie Chambers is a professor of accounting at Texas A&M University–Corpus Christi in Corpus Christi, TX. Joseph Brophy is with Joseph D. Brophy, CPA, P.C., in Dallas, TX. They are both members of the AICPA Tax Division’s IRS Practice and Procedures Committee. For more information about this column, contact Prof. Chambers at email@example.com.