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The Dead Have Choices: 2010 Estate Tax Options

The 2010 Tax Relief Act establishes an exclusion from estate taxes for $5 million dollars per person, effective all of 2010 through December 31, 2012. But wait, 2010 was practically over by the time this legislation passed. Under the old rules, the estates of those who died were off the hook for estate taxes in 2010. Did that change?

Not exactly. Now there’s a choice. The Tax Relief Act gave estate executors a choice between no estate taxes – and the right to use the new estate tax law. Why would anyone want to subject an estate to taxes if they can opt out? There are actually some pretty sound reasons to consider this. Let me explain.

In 2010 with no estate taxes, larger estates also lost the right to a step-up in basis. ‘Step-up’ means the tax basis of the estate’s assets rise to whichever is lower: either cost or their fair market value (FMV) at the date of death–or optionally, 6 months after death  (if the overall estate value is lower). The ‘step-up’ concept is important for two types of assets – highly-appreciated assets and assets whose cost is difficult to prove due to the passage of time, modifications of assets, and lost records.

In plain English, here’s an example. Mildred, a little old lady built up her stock portfolio over 30 or 40 years, a little bit at a time. The original records for those accounts are nowhere to be found. She was one of my clients, early in my tax practice. She was in the later stages of Alzheimer’s disease, so there was no way to ask her about the purchases. The stocks had split an unknown number of times – or perhaps experienced reverse splits. Companies had been split off, issuing new stocks. The family couldn’t possibly figure out where to start. Due to the step-up in basis, when Mildred died, we didn’t have to play detective and research all her purchase prices and trace the splits. We simply recorded the FMV on the date of death – and the heirs could sell the stocks without paying any capital gains taxes on a generation of appreciation.

Let’s go back to the original rules for 2010. The estates of people dying in 2010 did get a limited step-up in basis– for up to $1.3 million in assets. When there was a surviving spouse, an additional $3 million would get the step-up treatment. For estates larger than $1.3 million (or $4.3 million), the executor could allocate the step-up to specific assets. The rest of the estate’s basis would be based on cost, depreciation and other adjustments over time. While the estate would avoid all federal estate taxes, the capital gains taxes might be significant – even at 15%.

Think about a fully depreciated building with a FMV of $8 million, with a basis of $1 million. After allocating $4.3 million (assuming a surviving spouse), the federal capital gains taxes would be over $450,000. Electing to use the new rules in the 2010 Tax Relief Act, the estate would have a $10 million estate tax exclusion. The heirs would pay no capital gains at all.

That’s why you may want to elect to use the new federal estate tax law instead of avoiding estate taxes altogether.  (Note: Your state’s estate tax laws may be very different from the federal rules and it’s important to find out how state rules impact the overall estate.)

Whatever you decide, there is paperwork to file – even when there are no estate taxes. One catch: The IRS has not created the forms yet.

Eva Rosenberg, EA, is the publisher of TaxMama.com. Rosenberg is the author of several books, including the newest edition of “Small Business Taxes Made Easy.” She also teaches a tax-pro course at IRSExams.com.


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About The Tax Blog

  • The Tax Blog brings together a team of award-winning tax journalists from the Dow Jones network and around the web to examine the tax issues, changes and legislation that affect families, investors and small business owners. Our contributors include Tax Report columnist Laura Saunders (WSJ), Tax Guy columnist Bill Bischoff and senior reporter Jilian Mincer (SmartMoney.com), retirement-focused reporter Anne Tergesen (WSJ), wealth management writer Arden Dale (Dow Jones Newswires), TaxWatch columnist Eva Rosenberg and personal finance reporter Andrea Coombes (MarketWatch), and reporter Alyssa Abkowitz (SmartMoney). They’ll provide the latest news and insight, mine the tax code for tips and loopholes, and answer your questions about tricky tax situations. Contact the The Tax Blog with ideas, suggestions or tax questions at thetaxblog@dowjones.com.