February 2011

Family Tax Planning Forum

By Robert S. Keebler

2010 Tax Relief Act Sparks Both Relief and Anxiety

T
he 2010 tax year certainly proved to be one
of the most interesting tax years, particularly
in the area of estate planning. While there
is now some clarity regarding the estate, gift and
GST tax law for the next couple years, there still is
a bit of uncertainty as to how to administer estates
of decedents, especially those who passed away
in 2010. In my October 2010 Taxes column,1 we
discussed the date-of-death basis step-up provi-
sions of the prior tax law under Code Sec. 1014
and also discussed, in detail, the new “modified
carryover basis” rules under Code Sec. 1022. In this
column, we will briefly revisit the “modified car-
ryover basis” rules again and compare these rules
against the recently enacted estate, gift and GST
tax law provisions of the Tax Relief, Unemployment
Insurance Reauthorization and Job Creation Act of
2010 (“2010 Tax Relief Act”) (P.L. 111-312).
When the “modified carryover basis” rules of
Code Sec. 1022 were first enacted under Section
542(a) of the Economic Growth and Tax Relief
Reconciliation Act of 2001 (EGTRRA) (P.L. 107-
16), few tax planners thought the day would come
where they would be faced with the challenge of
determining how to apportion the $1.3 million
basis increase under Code Sec. 1022(b) or the
basis increase of up to $4.3 million in the case of
Robert S. Keebler, CPA, M.S.T., is a a married decedent (when using the $3 million
Partner with Keebler and Associates in spousal basis increase under Code Sec. 1022(c)).
Green Bay, Wisconsin. With the retroactive reinstatement of the estate,

Taxes—The Tax Magazine® 5

Family Tax Planning Forum

Table 1. In general, for estates that are $5

million or less in 2010, electing into
Elect out Elect in Difference the estate tax will be advantageous in
Gross Estate $5,000,000 $5,000,000 that (1) there will not be any estate
Less: Exemption - 5,000,000 - 5,000,000
tax (assuming no prior taxable gifts
were made), and (2) the assets of the
Taxable Estate $0 $0
estate will receive a full basis step-
Estate Tax @ 35% $0 $0 $0 up under Code Sec. 1014 (unless, of
course, the original basis of an asset
FMV of Assets $5,000,000 $5,000,000 is greater than its date-of-death fair
Less: Original Basis - 2,800,000 - 2,800,000 market value). For estates greater
Less: Basis Increase - 1,300,000 - 2,200,000 than $25 million, it will generally
Capital Gain $900,000 $0
make more sense to elect out of the
estate tax in 2010 because the estate
Capital Gains Tax @ 15% $135,000 $0 ($135,000) tax savings will outweigh any income
TOTAL TAXES $135,000 $0 ($135,000) tax cost from the reduced basis step-
up under Code. Sec. 1022. For those
estates between $5 million and $25
million, the decision to elect into
Table 2.
or out of the estate tax requires a
more comprehensive mathematical
Elect out Elect in Difference
analysis.
Gross Estate $35,000,000 $35,000,000 With these points in mind, it is possible
Less: Exemption - 35,000,000 - 5,000,000 to calculate a break-even point for just
Taxable Estate $0 $30,000,000 about any size estate. Because the “elect
out” option becomes more favorable as
Estate Tax @ 35% $0 $10,500,000 $10,500,000 the size of the estate increases, any estate
FMV of Assets $35,000,000 $35,000,000
larger than the break-even point would
be better off electing out of the estate tax
Less: Original Basis - 25,000,000 - 25,000,000
and falling under the modified carryover
Less: Basis Increase - 1,300,000 - 10,000,000 basis rules of Code Sec. 1022. On the
Capital Gain $8,700,000 $0 other hand, any estate at or smaller than
the break-even point would be better off
Capital Gains Tax @ 15% $1,305,000 $0 ($1,305,000)
electing into the estate tax and falling
TOTAL TAXES $1,305,000 $10,500,000 $9,195,000 under the basis step-up rules of Code
Sec. 1014.
This analysis can be generally summed
up using the formula shown in Chart 1.
gift and GST taxes for 2010 under 2010 Tax Relief
Act, however, the decision-making becomes even Chart 1.
more complicated.
Factors
Deciding whether to “elect out” of the estate tax X = Gross estate
in 2010, whereby the modified carryover basis Xb = Cost basis of gross estate
rules of Code Sec. 1022 would apply, or “elect Y = Estate tax exemption
into” the estate tax, whereby the date-of-death Z = Modified carryover basis increase
Ry = Estate tax rate
basis step-up rules of Code Sec. 1014 would ap- Rz = Income tax/capital gains tax rate
ply, will largely depend on both the size of the
estate and the composition of the assets (e.g., Formula
(X – Y) x Ry = ([X – Xb] – Z) x Rz
capital assets, depreciable assets, IRD, etc.) within
the estate.

6 ©2011 CCH. All Rights Reserved.

 February 2011

Example 1. John, age 80 and single, Table 3.

dies in 2010 with a $5 million gross
estate. John’s gross estate consists of a Date-of-Death FMV Adjusted Cost Basis Unrealized Gain
variety of assets with an aggregate cost Capital assets $10,000,000 $3,000,000 $7,000,000
basis of $2.8 million. Given these facts,
Depreciable assets
John’s estate would elect into the estate (Code Sec. 1245) 5,000,000 500,000 4,500,000
tax because the estate will not incur an Depreciable assets
estate tax and will get a full basis step- (Code Sec. 1250) 5,000,000 1,000,000 4,000,000
up. This is shown in Table 1. Total estate $20,000,000 $4,500,000 $15,500,000

Example 2. Jane, age 85 and single,

dies in 2010 with a $35 million gross Table 4.
estate. Jane’s gross estate consists of
a variety of assets with an aggregate Elect out Elect in Difference
cost basis of $25 million. Given Gross Estate $20,000,000 $20,000,000
these facts, Jane’s estate would elect Less: Exemption - 20,000,000 - 5,000,000
out of the estate tax because the Taxable Estate $0 $15,000,000
estate will have an estate tax that is
Estate Tax @ 35% $0 $5,250,000 $5,250,000
greater than any income tax liabil-
ity it would incur upon the future Capital Assets
sale of the assets. This is shown in FMV of Assets $9,000,000 $9,000,000
Table 2. Less: Original Basis - 3,000,000 - 3,000,000
Less: Basis Increase - 0 - 6,000,000
The previous two examples are a
bit simplified because they only as- Capital Gain $6,000,000 $0

sumed that all the assets held by each Capital Gains Tax @ 15% $900,000 $0 ($900,000)
estate were capital assets subject to
long-term capital gains tax treatment Code Sec. 1245 Assets
upon disposition. However, in many FMV of Assets $5,000,000 $5,000,000
estates this will not be the case. When Less: Original Basis - 500,000 - 500,000
considering whether to elect into or Less: Basis Increase - 1,300,000 - 4,500,000
out of the estate tax, the trustee and/or
Net Gain (100% Recapture) $3,200,000 $0
executor will need to look at the size
of the estate as well as the composi- Income Tax @ 35% $1,120,000 $0 ($1,120,000)
tion of the estate’s assets. In this case,
Code Sec. 1250 Assets
the trustee and/or executor will need
to ascertain if any of the assets are (1) FMV of Assets $5,000,000 $5,000,000

considered “income in respect of a Less: Original Basis - 1,000,000 - 1,000,000

decedent” (IRD), (2) assets depreciated Less: Basis Increase - 0 - 4,000,000
by the decedent, which are subject to Net Gain (100% Recapture) $4,000,000 $0
depreciation recapture upon disposi- Income Tax @ 25% $1,000,000 $0 ($1,000,000)
tion, or (3) assets that may be used
TOTAL TAXES $3,020,000 $5,250,000 $2,230,000
for future depreciation. This issue is
illustrated in Example 3.

Example 3. Martha, age 75 and single, at the income tax rate (i.e., 35 percent), and they liq-
time of her death in 2010 had the assets shown uidate all of the estate’s assets immediately.
in Table 3 in her taxable estate. Now assume
that, for income tax purposes, the beneficiaries Based on these assumptions, Table 4 summarizes
of Martha’s estate are all at the highest marginal the tax liability under each scenario assuming

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Family Tax Planning Forum

Martha’s estate either elects into or out of the when determining whether to elect into or out of
estate tax. the estate tax.
Keep in mind that when preparing a comparative
analysis to determine which option is more advan- Conclusion
tageous, one must also take into consideration the
present value of the tax liabilities. Example 3 was The 2010 tax year certainly proved to be interest-
oversimplified in that it assumed that the beneficia- ing, if not a little nerve-racking, from a tax planning
ries were going to immediately sell all of the estate’s perspective. While there is at least some short-term
assets. In most cases, though, the assets of the estate estate tax relief, there are still enough open issues for
will not be disposed of for quite some time, thereby estates in 2010 that can cause considerable anxiety
decreasing the present value of the future income for trustees, executors and their advisors. Neverthe-
tax liability. Finally, one must take into consideration less, with careful planning and analysis, a prudent
the additional basis increase for future depreciation decision can still be made.
that would be allowed for the beneficiaries under Endnotes
the “elect into” scenario (under Code Sec. 1014). In 1
Robert S. Keebler, Family Tax Planning Forum, Choosing Between Code
this case, the present value of the future income tax Sec. 1022 Modified Basis Step-up and Applying the 2009 Estate Tax
benefit of any depreciation needs to be considered Rules for Decedents Dying in 2010, Taxes, Oct. 2010, at 5.

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