In December, President Obama signed into law a measure to reinstate the federal estate tax for people who died in 2010, retroactively applying a 35 percent maximum estate tax rate and a $5 million estate tax exemption.
The new law allows those estates to opt out of the tax. For some estate executors, a choice must be made between paying the tax or not paying the tax. Why would an executor choose to pay the estate tax? There's a good reason.
No estate tax, no step-up in basis
If an executor chooses to elect out of the estate tax, estate property will receive a modified carryover income tax basis, and not a step-up (or step-down) in basis. A step-up (or step-down) generally means that the tax basis of the estate's assets increases (or decreases) to fair market value at the date of death. This is important for two types of assets; assets that have greatly appreciated in value and assets that have a cost basis that is difficult to prove. The modified carryover basis regime allows the decedent's cost basis to be increased by $1.3 million, with an additional $3 million increase for assets received by surviving spouses.
COMPARING TAX RESULTS
Executors will need to evaluate which tax system will be more beneficial to the estate: estate tax or capital gains tax. Estates valued at less than $5 million may want to choose the estate tax system to get an income-tax-free step-up in basis on appreciated assets.
Certain larger estates might choose the estate tax if the estates calculate that the reduction in capital gains tax on any sale of inherited assets with a stepped-up basis will more than offset the increase in estate tax.
Other larger estates might choose no estate tax if the estates calculate that the estate and its beneficiaries will pay less in capital gains tax on any sale of inherited assets than the estate tax that would otherwise be due.
FILING DEADLINES
The new law extends the estate tax return filing and payment deadline to Sept. 17, 2011, for the estates of people who died between the start of 2010 through and Dec. 17, 2010. This is also the deadline for filing IRS Form 8939 if the estate elects out of the estate tax in favor of the modified carryover basis regime.
Sept. 17, 2011, is also the deadline for making qualified disclaimers from these estates. Estates should also check state law for the applicable state deadlines for making a qualified disclaimer.
The estates of decedents dying after Dec. 17, 2010 must follow the usual nine-month deadlines for filing tax returns and making tax payments and disclaimers.
Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Travis Flenniken, CFA, is vice president of investments with DeMoss Capital - demosscapital.com. Submit questions to his attention by writing to Business Editor Dave Flessner, Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by e-mailing him at dflessner@timesfreepress.com