Posted by Ridge Dickey on Wed, Dec 30, 2009
Congress
adjourned before Christmas without passing legislation that would have
prevented estate tax repeal for calendar year 2010. The estate tax will
reappear in 2011, but with the rates and exemptions in effect in 2001.
Please
keep in mind that the federal gift tax remains in effect during 2010
with the lifetime $1 million exemption and the annual exclusions ($13
thousand for both 2009 and 2010).
Not only is the federal
estate tax cloaked for 2010, but also the "step-up" in basis rules will
not apply with limited exceptions. Rather carryover basis rules with
important exemptions will determine the income tax basis of a
decedent's heirs. This article will discuss how the suspension of the
step-up in basis rules that will apply to the estates of decedents who
die in 2010 impact testamentary documents
As the law reads
until January 1, 2010, the federal income tax basis of assets of a
decedent take a new basis equal to their fair market values at death.
So if a 2009 decedent owned 100 shares of a stock that cost $10,000 but
have a value of $30,000 on the date of death, the tax basis is
$30,000. The result is to decrease the taxable gain or increase the
loss on a subsequent sale.
As to decedents who die in 2010, there are two exceptions to the carryover basis rules.
1. All Decedents.
For all decedent's whether single or married, the personal
representative may allocate an "aggregate basis increase" of up to $1.3
million to the basis of the decedent's assets. The $1.3 million is an
allocation of additional basis on top of the decedent's basis.
The $1.3 million aggregate basis increase is further increased by the decedent's:
- unused capital loss carryovers;
- unused net operating loss carryovers;
- the
inherent losses in assets that would produce certain types of losses if
sold by decedent (incurred in trade or business, transactions entered
into for profit, casualty losses).
To
illustrate, assume a decedent had an asset worth $2 million at death
with a cost basis
of $.5 million. He also had an unused capital loss carryover of $.1
million. Allocating all of the $1.3 million aggregate basis increase
plus the $.1 million loss carryover to this asset
would give it a tax basis of $1.9 million.
2. Bonus for Married Decedent's: Aggregate Spousal Property Basis Increase.
Now is the time to pop the cork on the champagne and let its affect
counter the mind-twisting concept of the "aggregate spousal property
basis increase."
Actually,
the aggregate spousal property basis increase is only a number, and
that number is $3 million. But there are other defined terms and of
course operating rules.
"Qualified spousal property" means "outright transfer property" and "qualified terminable interest property."
The
term "outright transfer property" for the most part is self explanatory
(I won't get into the a couple of potential pitfalls here).
As
to qualified terminable interest property, it's the same concept as
QTIP property under the federal estate tax regime. The primary
requirements are that the property pass from the decedent, the
surviving spouse gets the income for life, and no person other than the
surviving spouse can appoint the property to anyone other than the
surviving spouse during the surviving spouse's lifetime.
So
up to $3 million can be allocated to qualified spousal property to
increase the basis by $3 million. This basis increase is in addition
to the aggregate basis increase of $1.3 million (subject to increase by
certain losses).
The
carryover basis rules care contained in section 1022 of the Internal
Revenue Code. It contains a unique rule for community property which
reads as follows:
Property which represents the surviving spouse’s
one-half share of community property held by the decedent and the
surviving spouse under the community property laws of any State or
possession of the United States or any foreign country shall be treated
for purposes of this section as owned by, and acquired from, the
decedent if at least one-half of the whole of the community interest in
such property is treated as owned by, and acquired from, the decedent
without regard to this clause.
It
appears this rule would operate to allow a surviving spouse's interest
in community property to receive an allocation of the the decedent's $3
million spousal basis increase. I don't think this statutory provision
can be construed as allowing a basis increase of up to $6 for community
property.
Estate planning
practitioners and their clients weren't suppose to have to deal with
all this technical, complex mess because Congress was going prevent the
estate tax from lapsing in 2010.
One
ameliorating factor is that many testamentary documents in place for
married persons provide for a Bypass Trust (sometimes called a "Credit
Shelter Trust" or "Exemption Equivalent Trust") and a Marital Trust.
The Marital Trust is almost always drafted as a QTIP trust. Where
these instruments are in place, they can be patched up with a bandaid
to hold them over until 2011 (or until Congress retroactively
reinstates the estate tax for 2010 which may result in constitutional
challenges).
In
general, the way it works is to make sure the patch is drafted so that
the aggregate basis increase is allocated first and that the property
to which it's allocated goes to the Bypass Trust. If there is
appreciated property in the decedent's estate remaining, then allocate
the aggregate spousal property basis increase to property going to the
Marital (QTIP) Trust.
All
of the other property that would have passed to either the Bypass Trust
or the Marital Trust if Congress had not let the estate tax lapse, goes
to the Bypass Trust.