Why is this Topic Important to Wealth Managers? This blogticle represents part two of five in a series on the unified estate and gift tax as well as the portability of the spousal credit. Most wealth managers are aware of the new changes to the federal estate and gift tax structure with the unification and increased exemption amount of five million dollars. This week we discuss the estate and gift tax in detail so that wealth managers are well prepared to address client planning needs.

The Tax Relief Act of 2010 first reinstates the estate taxes effective for decedents dying and transfers made after December 31, 2009. The estate tax applicable exclusion amount is $5 million under the provision and is indexed for inflation for decedents dying in calendar years after 2011, and the maximum estate tax rate is 35 percent. [1]

Additionally, for gifts made after December 31, 2010, the gift tax is reunified with the estate tax, with an applicable exclusion amount of $5 million and a top estate and gift tax rate of 35 percent.

Also, for transfers made at death after December 31, 2010, the new law generally provides for ‘stepped-up” basis in property passing from the decedent; the carryover basis rules for gifts is unaffected. Gain or loss, if any, on the disposition of property is measured by the taxpayer’s amount realized (i.e., gross proceeds received) on the disposition, less the taxpayer’s basis in such property.[2] Basis generally represents a taxpayer’s investment in property, with certain adjustments required after acquisition. For example, basis is increased by the cost of capital improvements made to the property and decreased by depreciation deductions taken with respect to the property.

Under the new law the basis of property passing from a decedent’s estate is given the fair market value on the date of the decedent’s death (or, if the alternate valuation date is elected, the earlier of six months after the decedent’s death or the date the property is sold or distributed by the estate). This step up in basis generally eliminates the recognition of income on any appreciation of the property that occurred prior to the decedent’s death. If the value of property on the date of the decedent’s death was less than its adjusted basis, the property takes a stepped-down basis when it passes from a decedent’s estate. This stepped-down basis eliminates the tax benefit from any unrealized loss. [3]

Under the modified carryover basis regime, recipients of property acquired by gift, bequest, devise, or inheritance receive an adjusted basis or the fair market value of the property. Thus, the character of gain on the sale of property received from a gift is carried over to the donee. For example, real estate that has been depreciated and would be subject to recapture if sold by the donor will be subject to recapture if sold by the donee. [4]

Tomorrow’s blogticle will continue our weeklong series on the gift and estate tax.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] TRA of 2010 § 302(a).

[2] IRC Sec. 1001.

[3] There is an exception to the rule that assets subject to the Federal estate tax receive stepped-up basis in the case of ‘‘income in respect of a decedent.’’ See IRC Sec. 1014(c). The basis of assets that are ‘‘income in respect of a decedent’’ is a carryover basis (i.e., the basis of such assets to the estate or heir is the same as it was in the hands of the decedent) increased by estate tax paid on that asset. Income in respect of a decedent includes rights to income that has been earned, but not recognized, by the date of death (e.g., wages that were earned, but not paid, before death), individual retirement accounts (IRAs), and assets held in accounts governed by section 401(k).

[4] U.S. Congress. Joint Committee on Taxation. General Explanation of Tax Legislation Enacted in the 111th Congress, 556 (JCS-2-11). Text from: Committee Reports. Available at: http://www.jct.gov/publications.html?func=showdown&id=3777 (last accessed April 6, 2011).

Tags: Carryover basis, Cost basis, Estate tax in the United States, Generation-skipping transfer tax, Gift tax in the United States, Individual Retirement Account, Tax, United States Congress Joint Committee on Taxation

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