Lawyers Journal

2010 estate tax options

With the enactment of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 20101 (the act), we saw the return of the estate tax for 2010 estates. However, in order to avoid a constitutional challenge to such a late change in the tax law, 2010 estates were given a choice as to whether to be subject to the federal estate tax or not. That might sound like a pretty easy decision, but it isn't quite that simple. Each situation must be analyzed independently to determine the best alternative for the estate.

The options

The act states that all 2010 estates are by default subject to a federal estate tax of 35 percent, with a $5 million applicable exclusion amount.2 The assets in these estates will enjoy a step-up in basis to fair market value at the date of death under Internal Revenue Code (IRC) Section 1014. Alternatively, an election can be made to opt out of the 2010 estate tax.3 If this election is made, the assets in the estate are subject to the modified carryover basis system detailed in IRC Section 1022.

Carryover basis

In simple terms, the carryover rule states that the basis of the property acquired from a decedent is the lesser of the adjusted basis of the decedent or the fair market value of the property at the date of death of the decedent. There are, however, a couple of exceptions to this rule which are critical in the analysis of whether to elect out of the estate tax.

IRC Section 1022(b) allows an allocation of up to $1.3 million in basis increase to the assets of any decedent (either held outright, jointly or in a qualified revocable trust) which are subject to the carryover basis rules (and that amount is further increased by capital loss carryovers, net operating loss carryover and losses that would have been allowable under IRC Section 165 had the property been sold at fair market value immediately before the decedent's death).

IRC Section 1022(c) allows an additional $3 million in basis increase allocation to the same set of assets, but only to the extent that they either qualify as qualified terminable interest property or pass to a surviving spouse outright. In the case of either basis allocation rule, you cannot "step-up" a particular property's basis in excess of its fair market value.

Making a decision

For some estates, the decision of which route to take is fairly easy. For example, for any estate under $5 million, electing to stay subject to the estate tax and taking the basis step-up is almost always going to be the best decision. Conversely, an estate far in excess of $5 million with relatively little built-in gain in the underlying assets is most likely going to be better off opting out of the estate tax and addressing the carryover basis with the allocation of available basis increase under Section 1022.

For those estates for which the answer isn't quite so obvious, some number crunching will be required, calculating the potential estate tax as compared to the potential tax on assets to which the available basis increase does not completely, or at all, step basis up to fair market value.

When making this decision, other factors may also need to be considered. For example: Are formula bequests (or funding formulas in a trust) materially altered by the decision to opt out (or in) of the estate tax, thereby creating conflict among the beneficiaries? In allocating available basis increase to assets with carryover basis, can the allocation be made equitably among the beneficiaries? When is the property going to be sold, and does that impact whether or not carryover basis (without an estate tax) is preferred?

Timing

Usually Form 706, the Federal Estate Tax Return, is due nine months from the date of death. However, the act was not passed until mid-December 2010. In order to give everyone sufficient time to analyze the rules and make the proper decision for each estate, the estate of any decedent who died prior to the enactment of the act may file Form 706 up to nine months from the date of enactment,4 thereby making Sept. 19, 2011, the due date for the majority of 2010 estates.5

Bunker L. Highmark, a lawyer in the Wellesley office of Gilmore, Rees & Carlson PC, concentrates his practice in estate and tax planning and estate administration. He can be reached at [e-mail bhighmark].

1Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, H.R. 4853, 111th Congress (2010)
2Id., Sec. 301(a) and 302(a) (modifying Sec. 2010(c))
3Id., Sec. 301(c)
4Id., Sec. 301(d)
5Nine months from the date of enactment is actually Sept. 17, which falls on a Saturday in 2011, thereby making the following Monday, Sept. 19, the due date.

©2014 Massachusetts Bar Association