The IRS has dropped the second shoe, giving taxpayers guidance through the complex procedural machinations they must follow to avoid the 2010 estate tax.

The IRS released two pieces of guidance for estates of 2010 decedents. Advisor’s Journal covered Notice 2011-66 in a previous edition [see IRS Finally Issues Guidance on 2010 Estate Tax (CC 11-160)]. Today we discuss the second component, Revenue Procedure 2011-41, which provides a safe-harbor for executors of estates of 2010 decedents and beneficiaries of those estates. If the safe-harbor procedure is followed and the executor doesn’t take a contradictory position on a return, the IRS will not challenge the election against the estate tax or the basis allocations made by the executor.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of estates of 2010 decedents in Advisor’s Journal, see IRS Finally Issues Guidance on 2010 Estate Tax (CC 11-160), What Next? ILITs and Estates under 5MM (CC 11-114), & Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122).

For in-depth analysis of the estate tax, see Advisor’s Main Library: Estate, Gift and GST Taxes

Estates of decedents who died in 2010 finally have guidance from the IRS on how to opt out of estate tax treatment and allocate carryover basis to estate property. The guidance is long overdue, and leaves little time for estates to make decisions that could have a massive tax impact.

Under the guidance, Notice 2011-66, to opt out of the estate tax and apply the new carryover basis rules, an executor must file Form 8939, Allocation of Increase in Basis for Property Acquired From a Decedent. The due date for the form is November 15, 2011. But despite the November deadline, Form 8939 and its instructions will not be available until early this fall. The IRS has, however, released a draft version of the form.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the new estate tax in Advisor’s Journal, see What Next? ILITs and Estates under 5MM (CC 11-114), Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122), 2010 Estates: To Elect or Not to Elect (CC 10-124) & Obama Tax Agreement Passed by House (CC 10-117).

For in-depth analysis of the estate tax, see Advisor’s Main Library: Estate, Gift and GST Taxes.

Why is This Topic Important to Wealth Managers? This blogticle serves as a reminder and review of the treatment of deceased estates from 2010 (making an a section 1022 election).

Estate Tax

The IRS recently published guidance [1] with regard to the time and manner in which the executor of the estate of a decedent who died in 2010 elects, pursuant to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, [2] (TRA), to have the estate tax not apply and to have the carryover basis rules in section 1022 apply to property transferred as a result of the decedent’s death.

Generally, subtitle A of title V of the Economic Growth and Tax Relief Reconciliation Act of 2001, [3] (EGTRRA) enacted section 2210, which made chapter 11 (the estate tax) inapplicable to the estate of any decedent who died in 2010 and chapter 13 (the GST tax) inapplicable to generation-skipping transfers made in 2010.

On December 17, 2010, TRA became law, which reinstated the estate and GST taxes.  However, section 301(c) of TRA allows the executor of the estate of a decedent who died in 2010 to elect to apply the Internal Revenue Code (IRC) as though section 301(a) of TRA did not apply with respect to chapter 11 and with respect to property acquired or passing from the decedent (within the meaning of IRC section 1014(b)).  Thus, TRA allows the executor of the estate of a decedent who died in 2010 to elect not to have the provisions of chapter 11 apply to the decedent’s estate, but rather, to have the provisions of section 1022 apply (Section 1022 Election).

Even though an executor may elect out of the estate tax under TRA, the provisions of chapter 13 (GST tax) nonetheless continue to apply.  Nevertheless, TRA, provides that the applicable tax rate for each GST occurring during 2010 is zero.  [4]

TRA also retroactively repealed section 2511(c), which treated each transfer in trust during 2010 as a gift unless the trust was treated as wholly owned by the donor or the donor’s spouse.  Because of this retroactive repeal, this section does not apply even if a Section 1022 Election is made.

GST

The GST tax was retroactively reinstated by TRA and applies to the estates of all decedents who died after December 31, 2009, regardless of whether a Section 1022 Election is made.  The GST tax is computed by multiplying the taxable amount by the applicable rate. [5]

Under the TRA the maximum federal estate tax rate for purposes of computing the GST tax on such a transfer is deemed to be zero which, when multiplied by any inclusion ratio, will result in an applicable rate of zero.  As under the law applicable to GSTs occurring prior to 2010, the only way to achieve a zero inclusion ratio for the transfer is to make a timely allocation of GST exemption to the transfer.

Next week’s blogticles will discuss planning opportunities.

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

[2] See section 301(c) TRA, P.L. 111-312 (124 Stat. 3296)

[3] P.L. 107-16.

[4] Section 302(c) of TRA.

[5] IRC Section 2602.

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.

[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).