Basis Calculations and Return Requirement As noted above, the stepped-up basis regime is replaced with a modified carry-over basis system. It is modified in two aspects. First, the executor can allocate $1.3 million of gain among the assets acquired from a decedent on a properly filed return. Second, for gifts to a surviving spouse, an additional $3 million of gain can be allocated. For jointly owned property between spouses, only the decedent’s one-half receives the opportunity for a step-up. Contribution rules similar to pre-2010 gifts apply in cases of jointly owned property of a decedent and any other person. Unfortunately, property that would have been included in a decedent’s estate pursuant to a power of appointment is not considered property acquired from a decedent. These allocation rules will require the filing of a new return under IRC § 6018 for large transfers which is defined as property (other than cash) having a fair market value over $1.3 million. Failure to file imposes a fine of $10,000. The information that will be required will exceed that which would have been required for an estate tax return. Basis cannot be allocated above fair market value. The value of the property remains relevant, however, because basis is the lesser of the carry-over basis or the fair market value on date of death.3 These new rules will necessitate investigation into the decedent’s basis so that built-in gain can be determined. While this requirement is no different than on a pre-death sale4, the option of holding property with a difficult-to-calculate basis until death will no longer be available. And, the perennial issue of date of death value remains. There are other significant issues related to the basis rules including excluding income in respect of a decedent from step-up availability (as under pre-2010 law). Thus, the current income tax treatment of qualified retirement plans, IRA’s, government savings bonds and like items will remain consistent with prior law. Transfers Into Trusts Treated as Taxable Gifts IRC § 2511 relating to transfers into trust in general is amended by the addition of a new subsection (c) which states that a transfer in trust shall be treated as a taxable gift unless the trust is a wholly owned grantor trust under the income tax rules. This addition eliminates transfers under prior law which were incomplete gifts for transfer 23
The Arkansas Lawyer
www.arkbar.com
tax purposes but shifted income for income tax purposes. Notwithstanding this change, old exclusions for annual gift exemptions (through “Crummey” withdrawal rights or otherwise), marital deduction gifts and charitable deductions remain in place. Regulations are specifically referenced in the statute and will have to be issued to avoid unintended consequences. What Happens in 2011? As noted above, 2011 starts as though 2010 never existed. Section 901 of EGTRRA provides, “(a) IN GENERAL – All provisions of, and amendments made by, this Act shall not apply…(2) in the case of title V, to estates of decedents dying, gifts made, or generation skipping transfers, after December 31, 2010. (b) APPLICATION OF CERTAIN LAWS – The Internal Revenue Code of 1986…shall be applied and administered to years, estates, gifts and transfers described in subsection (a) as if the provisions and amendments described in subsection (a) had never been enacted.” In other words, The Twilight Zone meets Back to the Future. While the effects of the sunset of EGTRRA for decedents dying after December 31, 2010, is clear, how is subsection (b) to be applied to what occurred in 2010? Will the basis rules applied in 2010 be relevant to a disposition of property in 2011 or beyond? As noted above, GST tax planning is especially uncertain with respect to taxable terminations or taxable distributions that will occur after 2010. Possibility of Retroactive Reformation Given the fact that 2010 and 2011 have such uncertainty surrounding the application of the transfer tax system, it is possible that Congress could retroactively reinstate the estate and GST taxes as of January 1, 2010. There is a constitutional question regarding the retroactive imposition of a tax (as opposed to a retroactive rate increase). In addition, given that Congress had ten years to reach a compromise before 2010 but was unable to do so, why should one expect a different result in 2010? What To Do With the changes noted above and the ones scheduled to come, what does one do? • Look past 2010 and if the client’s estate, or in the case of a married couple, the joint net worth is below $1 million and likely to remain so, no amendments are needed.
•
•
•
•
Review all bypass/marital deduction plans to see if an amendment or codicil is advisable to avoid an unintended disinheritance. Use of disclaimers or making specific reference to a death in 2010 or during any period in which the federal estate tax does not exist are two remedies. Include basis relevant provisions to authorize the executor to make basis step-up allocations for both marital and non-marital assets. Amend living wills or medical directives to authorize the agent to consider transfer tax matters in making medical decisions. Consider making taxable gifts to utilize the low gift tax rate, especially direct skips other than in trust.
Conclusion The above discussion is not intended to be a complete examination of transfer tax laws as of January 1, 2010. Nor is it intended to explore all the questions raised by them. Hopefully it alerts the reader to the changes and how they impact the reader’s practice. Endnotes 1. Note that the basis under pre-2010 law became the fair market value of the property on the date of death of the decedent. While generally referred to as “stepped-up” basis, it could also be “stepped-down” basis, especially in light of the declining market value of both financial and real estate assets in 2008 and 2009. 2. Arkansas’s estate tax was repealed when the federal treatment of a state death tax was changed from a credit to a deduction. Will reinstatement of the credit lead to a revival of Arkansas’s estate tax? 3. This is a classic “heads the taxpayer loses—tails the government wins” situation. Beneficiaries do not get the unlimited benefit of step-up in basis but receive the unlimited detriment of “step-down” in basis. 4. There is a fundamental difference in the basis rules related to gifts, however. As noted above, the 2010 rules require property inherited from a decedent to take the lower of the decedent’s basis or fair market value. IRC § 1015 remains unmodified and it provides that the recipient of a gift takes the property with a basis equal to the donor’s basis with the modification that for loss purposes (but not gain), if the fair market value is less than the donor’s basis, the fair market value will be the basis. n
Vol. 45 No. 1/Winter 2010 The Arkansas Lawyer
23