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Federal Estate Tax and Carryover Basis

Federal Estate Tax and Carryover Basis in 2010 – The Unthinkable

With its priorities elsewhere last year, the U.S. Congress failed to address a major problem with the 2001 federal estate tax law that may wreak havoc with estates of people who die in 2010.

Under the 2001 law, the federal estate and generation-skipping taxes are repealed in 2010 only, but the taxes return in 2011. Another change that takes effect this year relates to the income tax basis of inherited assets. Income tax basis is the value from which gain or loss on assets sold is measured. Under the law up until this year, the income tax basis of an asset is changed to its current value when its owner dies, as a general rule. But this year, this change in basis will not occur. Rather, the deceased owner’s income tax basis in assets will “carry over” to the persons who inherit the assets. This rule change applies only to assets inherited in 2010.

This strange and confusing situation resulted from a political and fiscal compromise in 2001. In the nine years since then, estate beneficiaries have enjoyed increases in the estate tax exemption, decreases in the rate of estate tax, and continued “step-up” in basis of inherited assets. Few imagined, however, that Congress would be unable to reach agreement in nine years on the ultimate fate of the tax. Yet the “unthinkable” has occurred, and with the way political winds are blowing these days, it’s hard to predict the outcome of a proposed 2010 budget provision that will permanently extend the tax at its 2009 levels – $3.5 million exemption per taxpayer, and a top rate of 45%. Another unknown is whether the provision, if successful, will be enacted retroactively to cover estates of decedents dying in 2010 prior to enactment.

As a result, there is great uncertainty, confusion and debate about whether federal estate tax will apply to estates of people dying in 2010, the rate and exemption of the tax, and whether folks who inherit assets this year will receive new or carry-over basis. Also concerning is what will happen in 2011 if Congress fails to act this year. Because the reappearance of the estate tax scheduled for next year is not at 2009 levels; instead, the exemption will be a mere $1 million (last applicable in 2003) and the top rate will be 55% (last imposed in 2001).

What should you do about this mess? Review your wills or living trusts and look for language dividing your estate into marital and family trust shares based upon your federal estate tax exemption. Schedule an appointment with your estate planning attorney if you are concerned about how this division formula will work if you die in 2010. If necessary, your attorney can draft an amendment to your will or trust substituting an alternative plan if you die in 2010.

Regarding income tax basis, personal representatives will be able to allocate $1.3 million of additional basis to appreciated assets in estates of people who die in 2010. Another $3 million of additional basis may be allocated to assets passing to a surviving spouse, but not if the assets pass to certain trusts for family support, which are commonly used in estate planning, and which will receive the entire estate of people who die in 2010 under most of the aforementioned division formulas. If you are married or have appreciation of over $1.3 million in your estate, you should review your estate plan with your attorney to make sure your estate can claim this additional spousal benefit, should the unthinkable happen to you in 2010.

If you want to schedule an appointment to begin estate planning or discuss an existing estate plan, please contact Mike Smeenk.

Mimi Abrams Goodman is no longer with the law firm of Frascona, Joiner, Goodman and Greenstein, P.C.
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