As I’ve mentioned before, Congress gave the personal representatives of estates of decedents who died in 2010 a choice:

1. Under the default rules, the estate would pay a 35 percent estate tax on assets that exceed the $5 million exemption and the beneficiaries would take a stepped-up basis in the property; or
2. The personal representative could elect to pay no estate tax, but would forfeit the full basis step-up.  Instead, the estate would be able to step up basis of up to $3 million for property left to a spouse and $1.3 million for property left to anyone.

The IRS recently published Revenue Procedure 2011-41, which gives personal representatives safe harbor guidance on basis allocation.  Under the Revenue Procedure, the $1.3 million and $3 million basis step-ups can be increased by the amount of the decedent’s unused net operating loss and capital loss carryovers.  If the decedent owned loss assets (assets worth less than their basis), the amount of the loss can also be added to the basis step up.

The Revenue Procedure also provides that when a beneficiary allocates basis to a depreciable asset, the added basis is treated as though it were part of a new asset that was first placed in use on the decedent’s death.

Personal representatives are required to report basis allocations by November 15, but there’s been a slight glitch: the IRS hasn’t released a final version of the form that personal representatives need to make this allocation (Form 8939).  The IRS has said that the form wouldn’t be due until at least 90 days after it is issued.

I recently completed a series of articles on Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312 (TRA 2010), which was signed into law by President Obama on December 17, 2010.  I have given a few presentations on this topic recently and decided to turn my materials into a series of articles.  The four articles are:

1. Introduction to the New Estate Tax Law – This article contains some of the background information and legislative history preceding the enactment of the new law.  I know you’ll want to skip ahead to the substance, but be warned: you can’t really understand the new Act unless you have a good grasp on what came before it and the situation we found ourselves in in 2010.
2. Estate Planning Under the New Estate Tax Law – This article discusses the substantive provisions of the act, including the new applicable exclusion amount (exemption) and tax rates, retroactive application of the Act, and a few planning pointers.
3. Portability Under the New Estate Tax Law – This article deals with a brand new feature of our estate tax laws–portability.  Portability allows the unused exemption of one spouse to be passed on to the surviving spouse.
4. Why Tax Planning Still Matters Under the New Estate Tax Law - This article explains why estate tax planning–including credit shelter/bypass planning–is as necessary now as ever.

TRA 2010 provides welcome relief from the uncertainty that plagued estate planners at the end of 2010.  But it is more of a patch than a fix.  Since TRA 2010 sunsets in 2012, we can expect these same issues to pop up again, along with more of the usual political wrangling over a permanent solution.  And if the past ten years are any indication, Congress will wait until the eleventh hour to provide any clarity.

If Congress fails to act by the end of 2012, the applicable exclusion will drop to $1 million and the estate tax rate will go up to 55 percent.  In my opinion, that is probably the least likely scenario.  It is more likely that the law will remain at current levels or drop to the $3.5 million exemption and 45 percent tax rate proposed by Senator Baucus and backed by many Democrats.  Of course, the possibility of another temporary fix of a different nature should not be ruled out.

Over the next two years, the higher applicable exclusion amount and lower transfer tax rates will slash the revenue from transfer taxes.  Outright repeal of the estate tax will be an easier sell in 2012, after revenue has dwindled enough to make it less of a hot-button issue.  Estate tax repeal is a more likely scenario than it has ever been and is likely to be re-proposed by the end of 2012.  Whether the modified carryover basis regime will also be reintroduced is anybody’s guess.

Note:  The higher exemption amounts will also mean much fewer tax returns will be filed.  Check out our post on the Estate Tax Stats for 2001-2009 to get  good idea of how drastic the decrease may be.  This means the IRS estate tax division will have some time on its hands. Expect high audit rates.

Given the continuing uncertainty, estate plans should not place undue reliance on the new Act or predictions about what Congress may or may not do before the end of 2012.  As we did in the years leading up to 2010, we must plan for the law as it is and try to build in as much flexibility as possible into the estate plan.

Tax planning still has an important role in most estate planning documents.  And in many ways, it will be more of a challenge over the next two years.  Estate plans must now be flexible enough to (1) adjust for fluctuations in the applicable exclusion amount, (2) plan for the possibility of estate tax repeal at the end of 2012 and reintroduction of modified carry-over basis regime, (3) plan for special elections, such as portability and basis adjustments; and (4) do all of this while meeting the client’s non-tax goals.

Trusts & Estates magazine recently compiled a list of resources for planning under the new Federal estate tax law.  The list references an article on portability that I wrote earlier this year (but don’t let that detract from the quality of the other resources featured there!).  Here’s the introduction to the list:

In the January 2011 Tech Review 2011 Tax Law Changes, we discussed the estate and gift tax changes created by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the 2010 Act) and their application to estate and gift tax related planning software. Enough time has now passed to note a number of new commentaries on the 2010 Act that have appeared on the Internet. Here are references to the most useful of these commentaries and summaries of their content …

The list should be required reading for attorneys who practice in the area of estate planning for high net worth individuals. Check it out.

The Wall Street Journal has an interesting/scary article on the new Global High Wealth Industry Group, a supergroup of auditors that was put together last year to audit the estates of high net worth individuals.  The members of the team come from the creme of the crop of the IRS’s corporate auditors.  

According to the article, the IRS’s new protocol for these individuals is to request that voluminous, hard-to-obtain documentation be produced on very short order (which isn’t suprising given the auditors’ corporate backgrounds).  

I’m afraid this isn’t the worst of it for high net worth individuals.  I’ve been speaking and writing a bit on the new estate tax law, and one point that I bring out in my presentations is the significant decrease in the overall number of estate tax returns that will be filed.  The number decreased from about 108,000 in 2001, when the estate tax exemption was $1 million, to under 35,000 in 2008, when the exemption was $1 million.  

With the estate tax exemption now set at $5 million, we can expect far fewer estate tax returns to be filed.  This will leave the estate tax auditors with some time on their hands.  We can expect an extremely high audit rate for estate tax returns in the near future.

So high net worth individuals will be getting hit at both ends.  During their lifetime, they are hit by a group of superauditors that with corporate-style document requests and turnaround times; at death, their estate tax returns will be closely scrutinized for any unjustified estate tax savings.  It seems the rich have entered the era of awful audits.

Trusts & Estates recently published a piece by Donald H. Kelley on how the 2011 tax law changes will affect estate tax calculation programs (for my prior posts on the new law will affect Florida personal representatives and probate attorneys, see here and here).  Kelley is an attorney, a technology writer for Trusts & Estates, and co-author of the Intuitive Estate Planner software.  His article is worth a read for Florida probate attorneys that rely on document assembly programs to assist them in estate planning or administration.

Speaking of the election to apply prior law for 2010, Kelly writes:

This election will pose great difficulty for executors in evaluating all of the factors that weigh on the decision whether to elect carryover basis.  Executors must, at least, have the basic tax costs of future sale of estate assets available to them.

Kelly believes that evaluating this election will require a computer program that will allow allocation of the basis increases under EGTRRA.  This isn’t surprising given that Kelly publishes computer software.  But self-interest notwithstanding, I think he has a good point.  It would be difficult (though not impossible) to factor in all of the criteria that go into the decision, which would include:

• When the asset might be sold;
• The tax rates that would apply to the asset when sold;
• Whether and how basis should be allocated among the decedent’s assets; and
• Whether depreciation recapture will apply (if real estate is involved).

Florida probate attorneys and others who represent personal representatives should take a look at the piece, especially if you rely on software to make tax-related decisions.