Immediately Redo Your Estate Plan to Capture the New Exemptions from Death Taxes; Obtaining Step Up in Basis in 2010

New Set of Death Taxes. For one year, 2010, there is a new death tax. In 2010, there is no estate tax or generation skipping tax that is paid by your estate. Instead, there is the abolition of step up in basis for one year. For most single widows and widowers with money, this change means that there will be higher taxes imposed on their heirs than was true in 2009 when there was an estate tax (click here for last weeks blog). And, the exemptions for the step up in basis tax require different estate plans than the ones that worked prior to 2010. Since most estate planners thought this would never happen, our informal survey shows that the estate plans of most people have to be changed and changed immediately to comply with the new law.

The New Death Tax. For 2010 only, when someone dies who is a US citizen or resident, the heirs of the decedent take the same “basis” in the property as the person who died or the value at the time of death, whichever is lower. Example: Dr. Sam bought 1000 shares of Google stock when it was $100 and when Dr. Sam died in 2010, Google shares were selling for $600 a share, for a gain of $500,000. If Sally, Dr. Sam’s daughter and heir, sells those 1000 shares she will have to pay the capital gain on those shares, which would be $500,000 times an estimated combined federal and state tax of 20% or about $100,000. If Sally waits to sell the shares in 2011, when the combined federal and state capital gain rate may be 35% or higher, Sally would pay $175,000 or more in taxes on just the Google stock.

First Step: Gather Those Receipts. Your first step in 2010 estate planning is to gather in a folder and have someone scan and put in computer storage, everything that proves what you paid for your assets and all improvements you have made on your residence. For estates over $1.3 million, the executor has to report data to the IRS so that the IRS can check up on the taxes the heirs report when they sell the assets they inherited.

Step Two: Capture the $1.3 Million Exemption. For everyone dying in 2010, there is a $1.3 million exemption that your heirs get to add to the tax basis of the property you owned at your death. This means for most Americans, they do not have to worry about this step up in basis problem because they have less than $1.3 million in their estate. This $1.3 million applies to property in revocable trusts or passed by will or without a will. But, it will not apply to assets you gave away or are in irrevocable trusts you do not own.

Step Three: The Big Prize: $3,000,000 Exemption. If you are married, your spouse can have $3,000,000 worth of property exempt from the no step up in basis rule. In 2009, five years after his wife died, Dr. Sam went to a high school reunion, saw Daisy, his high school sweetheart for the first time in 40 years, and they married three months later. Dr. Sam’s estate is worth $5 million, with a basis of $1 million and therefore potentially $4,000,000 is subject to taxes when inherited and sold by Sally. Dr. Sam updates his estate plan and sets up a trust so that when Dr. Sam passes away, $2.3 million goes to Sally in an asset protected trust and $2.7 million goes to Daisy in a trust that pays Daisy only the income for her lifetime. After Daisy passes away (she is 84), the balance goes to Sally. No estate tax because there is none in 2010. Sally has Dr. Sam’s receipts to show the $1,000,000 in basis and Sally receives the $1.3 step up in basis for the $2.3 million she receives in trust. The $2.7 million in trust for Daisy gets a full step up because it uses the $3,000,000 spousal exemption of Dr. Sam. The executor assigns assets that have no basis or have declined in value to the Daisy trust. Dr. Sam’s assets can be liquidated into cash after his passing and there is no federal or state income taxes (assuming the state follows the federal rules and no retirement accounts which generate taxes).

Dr. Sam Remarries but Does Not Update his Estate Plan. Alternatively, Dr. Sam does not know the law has changed or chooses not to update his estate plan. He left everything in his plan to Sally and nothing to Daisy. Sally is only able to find documentation of the basis of Dr. Sam of $500,000. Sally’s basis in the Dr. Sam’s property is $500,000 plus the $1,300,000 exemption for a total of $1,800,000, leaving $3,200,000 of Dr. Sam’s estate subject to capital gains taxes to be paid by Sally of about $640,000 or higher in later years.

Dr. Sam Does Re Do His Plan but they Live Together. As a third example, if Dr. Sam and Daisy lived together and did not get married, even if Dr. Sam left $2.7 million in trust for Daisy, the trust for Daisy would not qualify for the $3,000,000 exemption because they were not married. Daisy or Sally has a large tax bill when they sell assets. There has been a national trend of more unmarried households. The 2010 tax rules may result in more marriages; there is now a $3,000,000 penalty for not being married.

Plan Now. It is time to redo your plan to make sure it reflects what you want and your plan is current with the current law. Many estate advisors thought this day would never come and they now say that Congress will change the law retroactively and wipe out the step up in basis problem in 2010. But, Congress has not solved this problem since 2002 and you should not depend on Congress to do your planning for you.

Circular 230 Disclosure Notice
Pursuant to recently enacted U.S. Treasury Department Regulations, we are now required to advise you that, unless otherwise expressly Indicated, any federal tax advice contained in this document, including attachments and enclosures, is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed in this document.