Death and taxes: executors beware.

• Author: Chambers, Valrie

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act), P.L. 111-312, was signed by President Barack Obama on December 17, 2010, and revised tax law for estates of decedents dying in 2010, 2011, or 2012. The pre-2001 rules will be reinstated for deaths starting in 2013 unless Congress acts again before 2013. The new rules apply for 2010 unless an executor elects to use prior law. This election is made on Form 8939, Allocation of Increase in Basis for Property Acquired from a Decedent. However, the IRS has not yet released a final version of Form 8939. Elections for 2010 decedents can be made at a time not less than nine months from December 17, 2010, so estates of decedents dying in early 2010 can still be made timely.

The 2010 Tax Relief Act provides a $5 million estate tax exemption (indexed for inflation after 2011), a step-up in basis to market value, a top rate of 35% on taxable transfers (Sec. 2001(c), as amended by the 2010 Tax Relief Act, $302(a)(2)), and portability of unused exemptions between spouses for 2011 and 2012. Portability allows the estate of the second spouse to die to claim the unused exemption not claimed by the estate of the first spouse to die if the executor of the first-to-die spouse makes a timely election on the estate tax return of the first-to-die spouse. This effectively creates a $10 million exemption for married couples.

The 2010 Tax Relief Act also increased the lifetime gift tax exemption to $5 million starting in 2011. The generation-skipping transfer (GST) tax was reinstated, but the rate is zero for transfers in 2010, with a $1 million exemption. The GST tax is reunified with the gift tax ($5 million exemption) for 2011 and 2012.

The election in the 2010 Tax Relief Act to apply prior law may create traps for executors and affect beneficiaries, so understanding the election and preparing scenarios for 2010 deaths using old and new law is critical post-death planning. Some commentators believe that executors (and tax return preparers) may face litigation if the election decision adversely affects some classes of beneficiaries and their interests are not fully considered (and possibly should even compensate those heirs hit with higher income taxes that will result if an election is made to use the old law modified carryover basis instead of the new law step-up to fair market value (FMV)).

The old law was the Economic Growth and Tax Relief Reconciliation...