Estate Tax in the Gap Year - What it Means to You
In 2001, the US Congress voted to repeal all estate taxes for one year, 2010. At that time, it seemed likely that Congress would use the next nine years to craft a politically and socially acceptable package of estate taxes. As estate planners approached the end of 2009, few predicted we would enter 2010 with no action by Congress. Nonetheless, Congress did not act and seems unlikely to act until after the November 2010 elections. What does this mean for you?
· Individuals dying in 2010 are not subject to estate tax
· Individuals dying in 2010 have limited step up in basis
· There is no generation skipping transfer tax (GSTT) in 2010
· Gift tax on gifts over $1million is assessed at a 35% rate
What should you do now?
Many estate planning documents were not designed for the current state of affairs. We recommend that you work with an attorney experienced in this area to review your documents. Is it safe to do nothing and hope no one dies in 2010? The risk is that your plan will not be executed according to your original intentions.
· We recommend you discuss this with a qualified estate planning attorney
· For clients who are in frail health we recommend updating your documents now rather than waiting<?xml:namespace prefix = o />
· Some planners are suggesting adding a paragraph indicating what your intentions are for trust funding
· Others are rewording portions of the document, particularly those that use formula clauses
Limited step-up in basis
Under the old rules, when an individual died their assets received a new value, the fair market value on the date of death. The assets also had a long term holding period even if they were sold within one year of death, so gains were taxed at favorable capital gains rates. Under the limited step up rules, each individual can assign up to $1.3 million of step up to assets they own. If they are married, an additional $3 million is available to assign to assets that the spouse will keep or be held in a qualified trust (QTIP). The holding period is no longer automatically long term. If assets have decreased in value, they could have a step down. If you have capital loss carryforwards or net operating losses, those can also be added to basis in addition to the amounts above. So a strategy now could be to capture some of those losses to have them available upon death.
Everyone dying in 2010 with over $1.3 million in assets (other than cash) will be required to complete a form assigning step up in basis. The form, which does not yet exist, will be due when the 2010 income tax return is due. The IRS estimates that over 100,000 individuals will be required to file this form.
Here’s an example of step-up under the old and the current rules. Under the prior regime if you died owning a residence valued at $2.5 million that you purchased for $500,000, it would be worth $2.5 million on the day you died and your heirs could sell it incurring no income tax. Under the 2010 rules, it would be worth $500,000, creating a gain of $2 million when sold. As discussed above, some of the $1.3 million of step up might be assigned to this asset, changing the amount of gain to be reported.
Here is another example illustrating the use of a capital loss carryforward. Under the old rules, when a person died, their capital loss carryforwards were lost forever as were their net operating losses. Now, these can be added to the basis of assets, up to the fair market value. So, let’s say someone had some stock originally purchased for $50,000 that is now worth $400,000. They also had a capital loss carryforward of $100,000. In this case, assume the $1.3 million was already assigned to other assets. The stock could be stepped up from $50,000 to $150,000, the original cost, $50,000, plus the capital loss carryforward, $100,000. If the stock was now worth $80,000; it could only be stepped up to $80,000. The remaining $70,000 of capital loss could potentially be assigned to another asset.
As your CPAs we can help calculate existing basis and help you plan how to assign the step up available.
What should you do now to prepare for limited step up in basis?
Begin collecting information regarding your basis in various assets; here are some things to consider
· For portfolio items
o Did you purchase, inherit or receive as a gift? Each of these creates a different basis.
o Don’t forget that reinvested dividends are purchases of additional shares and are additional cost basis in your total portfolio
· For real estate
o Original purchase price
o Depreciation taken
· Pass-through entities, e.g. partnerships and S-Corporations
o Have you tracked basis over time?
· Do you own assets in other states
o Currently 17 states have their own estate tax regime and are continuing to assess estate tax
o Assets in states with gift tax will have step-up for state income tax but not for federal income tax
Gifting in 2010
The lower gift tax rate of 35% is alluring, but most people are exercising caution. It is possible that the 2009 rate of 45% could be reinstated, although the longer we get into 2010 the less likely that seems. Also, if 2010 gifts are made to grandchildren, possibly in trust, there is no way to allocate a GST exclusion ratio to the trust, so future distributions might not be protected from GST tax. Some planners have suggested lifetime gifts to a qualified terminable interest trust (QTIP) for the spouse with children as remainder beneficiaries. Within 9 months, if the 2009 law is not retroactively reinstated, the spouse could disclaim and the children would receive the gift at a 35% rate. Other gifting vehicles include LP and LLC interests.
What happens in 2011?
· The estate tax returns in 2011 on estates over $1 million at a maximum rate of 55%
· Step up in basis returns
· Generation skipping transfer tax returns in 2011 on transfers over $1m, indexed for inflation
· The tax rate on gifts over the exclusion amount of $1million per donor is now 35%; in 2011 it increases in graduated rates up to 55%
The technical wording is that it will be as if the law enacted in 2001 never existed. That could mean that the rules in 2010 never existed. So, instead of limited step-up in basis we are back to full step-up in basis. Some planners have suggested that, rather than selling in 2010, it would be better to borrow for purposes of cash flow and then sell in 2011. There is currently no IRS commentary or guidance on any of these issues. There are several legislative proposals, including an exclusion between $3.5 and $5.0 million and rates at a maximum of 45%, but nothing has passed.