Since the estate tax was technically repealed at the start of 2010 as a result of a sunset provision within EGTRRA, planning has been challenging due to uncertainty around potential legislative changes that would impose different rules. The signing of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. into law in December of 2010 brings some clarity – albeit short-term – and creates an interesting scenario for executors settling estates in 2010. Most followers are aware that the new law establishes a $5 million exemption amount and resurrects full step-up in cost basis on inherited assets. What might not be as clear to many is that the new law actually implements these new provisions retroactive to the beginning of 2010. However, estates in 2010 only have the choice of opting out of the new estate tax regime in favor of no federal estate tax. Consider two scenarios that highlight which option may be most beneficial:
- Estates up to $5 million, which include assets such as real estate and investments that have appreciated significantly since acquired.
In this scenario, it will most likely be beneficial to opt for the new estate tax structure, which would exempt $5 million in assets from estate taxes. Additionally, appreciated assets at death would benefit from full stepped-up cost basis, meaning that the appreciation from the time they were acquired to the date of death would escape long-term capital gains taxation.
- Estates larger than $5 million in assets.
Executors of larger estates (more than $5 million in net taxable assets) will likely opt for no federal estate tax in lieu of the step-up in cost basis benefit on inherited assets since the maximum 35% estate tax rate is much higher than the 15% tax rate on long-term capital gains. In this case, modified adjusted cost basis applies on inherited accounts, which means an aggregate of $1.3 million can be added to increase cost basis of assets left to non-spouses ($3 million for spousal property).
It’s critical for families to work with a qualified estate planning attorney to understand the ramifications of the new estate tax law and identify a strategy that is most beneficial based on the specific circumstances.