The impossible happens!
Dealing with temporary estate tax repeal

January 6, 2010

© 2010 by Michael C. Gray, CPA


The repeal of the federal estate tax and the federal generation skipping tax for 2010, enacted as part of the Bush tax cuts in the Economic Growth and Tax Relief Act of 2001 is scheduled to be effective January 1, 2010.

All of these years, commentators on the tax laws have said there was no way this repeal would become effective, but now it appears the "impossible" will happen.

Congress can pass retroactive legislation during 2010 to restore the tax. Whether it will is problematic. The House of Representatives passed a bill to make the estate tax as stated for 2009 permanent, but the legislation was stonewalled in the Senate, which was embroiled with Health Care Reform.

What are the results and related concerns with this "Cinderalla’s pumpkin" repeal?

For 2009, for U.S. citizens and certain residents, the estate tax exemption equivalent and generation-skipping tax exemption are $3.5 million. There is an unlimited marital deduction for surviving spouses who are U.S. citizens. This means most U.S. decedents already are exempt from estate tax.

Of more concern to all taxpayers, the tax basis, or "cost" to determine gain or loss for federal income tax reporting, is adjusted to the fair market value on the date of death or an alternate valuation date six months after death. The holding period for inherited property is automatically long-term, and the acquisition date is the date of death for determining depreciation.

For 2010, since the estate tax is repealed, many of the formulas built into wills and trusts that are written to minimize estate tax will be obsolete.

In addition, a "carryover" basis regime will become effective, and the attributes of property will become the same as for property received as a gift. The tax basis of inherited property will be the lesser of the adjusted basis of the decedent or the fair market value on the date of death. The holding period for inherited property will be same as for the decedent. This rule will create an inconvenience for beneficiaries who don’t know when the decedent acquired the property and for how much.

As relief for this situation, the executor may elect to allocate up to $1.3 million of additional basis (not to exceed the fair market value) to inherited property. If the decedent was a nonresident of the United States, only $60,000 of additional basis may be allocated.

Up to $3 million of additional basis may be allocated to property inherited by a surviving spouse. Property inherited by a surviving spouse includes property allocated to a Qualified Terminable Interest Property (QTIP) trust.

For decedents who have property in excess of the limits and multiple beneficiaries, there is clearly a conflict of interest about how these basis adjustments should be allocated.

Executors who are no longer required to file estate tax returns (or wouldn’t have been required to file an estate tax return under the law in effect for 2009) will have to file reports to the IRS about how the "additional basis" is being allocated.

The repeal of the federal estate tax for 2010 means the administration of estates of decedents dying during 2010 will be delayed while executors wait to see if Congress retroactively restores the estate tax and ask courts for guidance about how to allocate additional basis.

After 2010, the estate tax exemption equivalent is scheduled to return to $1 million and carryover basis is scheduled to expire. With the federal deficits we are experiencing, some representatives are inclined to just let the Bush tax cuts, including estate tax relief, expire.

What does this mean for you?

Especially if you are a senior citizen or in poor health and you have significant assets, you should consider having a codicil prepared for your will or trust to incorporate language in case the estate tax is not restored, including directions relating to the additional basis allocations.

Even if you are not a senior citizen and have good health, remember that accidents happen and that unexpected health changes can happen. You should still consider providing for these temporary changes in your will and/or trust.

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