With the enactment of the Tax Relief, Unemployment Insurance
Reauthorization, and Job Creation Act of 20101 (the
act), we saw the return of the estate tax for 2010 estates.
However, in order to avoid a constitutional challenge to such a
late change in the tax law, 2010 estates were given a choice as to
whether to be subject to the federal estate tax or not. That might
sound like a pretty easy decision, but it isn't quite that simple.
Each situation must be analyzed independently to determine the best
alternative for the estate.
The act states that all 2010 estates are by default subject to a
federal estate tax of 35 percent, with a $5 million applicable
exclusion amount.2 The assets in these estates will
enjoy a step-up in basis to fair market value at the date of death
under Internal Revenue Code (IRC) Section 1014. Alternatively, an
election can be made to opt out of the 2010 estate tax.3
If this election is made, the assets in the estate are subject to
the modified carryover basis system detailed in IRC Section
In simple terms, the carryover rule states that the basis of the
property acquired from a decedent is the lesser of the adjusted
basis of the decedent or the fair market value of the property at
the date of death of the decedent. There are, however, a couple of
exceptions to this rule which are critical in the analysis of
whether to elect out of the estate tax.
IRC Section 1022(b) allows an allocation of up to $1.3 million in
basis increase to the assets of any decedent (either held outright,
jointly or in a qualified revocable trust) which are subject to the
carryover basis rules (and that amount is further increased by
capital loss carryovers, net operating loss carryover and losses
that would have been allowable under IRC Section 165 had the
property been sold at fair market value immediately before the
IRC Section 1022(c) allows an additional $3 million in basis
increase allocation to the same set of assets, but only to the
extent that they either qualify as qualified terminable interest
property or pass to a surviving spouse outright. In the case of
either basis allocation rule, you cannot "step-up" a particular
property's basis in excess of its fair market value.
Making a decision
For some estates, the decision of which route to take is fairly
easy. For example, for any estate under $5 million, electing to
stay subject to the estate tax and taking the basis step-up is
almost always going to be the best decision. Conversely, an estate
far in excess of $5 million with relatively little built-in gain in
the underlying assets is most likely going to be better off opting
out of the estate tax and addressing the carryover basis with the
allocation of available basis increase under Section 1022.
For those estates for which the answer isn't quite so obvious,
some number crunching will be required, calculating the potential
estate tax as compared to the potential tax on assets to which the
available basis increase does not completely, or at all, step basis
up to fair market value.
When making this decision, other factors may also need to be
considered. For example: Are formula bequests (or funding formulas
in a trust) materially altered by the decision to opt out (or in)
of the estate tax, thereby creating conflict among the
beneficiaries? In allocating available basis increase to assets
with carryover basis, can the allocation be made equitably among
the beneficiaries? When is the property going to be sold, and does
that impact whether or not carryover basis (without an estate tax)
Usually Form 706, the Federal Estate Tax Return, is due nine
months from the date of death. However, the act was not passed
until mid-December 2010. In order to give everyone sufficient time
to analyze the rules and make the proper decision for each estate,
the estate of any decedent who died prior to the enactment of the
act may file Form 706 up to nine months from the date of
enactment,4 thereby making Sept. 19, 2011, the due date
for the majority of 2010 estates.5
Bunker L. Highmark, a lawyer in the Wellesley office of
Gilmore, Rees & Carlson PC, concentrates his practice in estate
and tax planning and estate administration. He can be reached at [e-mail bhighmark].
1Tax Relief, Unemployment Insurance Reauthorization
and Job Creation Act of 2010, H.R. 4853, 111th Congress
2Id., Sec. 301(a) and 302(a) (modifying Sec.
3Id., Sec. 301(c)
4Id., Sec. 301(d)
5Nine months from the date of enactment is actually
Sept. 17, which falls on a Saturday in 2011, thereby making the
following Monday, Sept. 19, the due date.