Posts Tagged ‘Stepped Up Basis’

The Impact of Estate Tax Repeal on Elder Law

Loss of Stepped-Up Basis Means Carry Over Basis

As things stand now (February 11, 2010) stepped-up basis in inherited assets has been drastically curtailed.  The estate tax went into automatic repeal on January 1, 2010, and with it went the stepped-up basis rules.  Whether those rules come back, and if so in what form and when, depends totally on Congress.

How Congress handles that could tremendously affect the country’s middle class elderly and their families who have counted on the ability to leave assets to younger generations at a tax basis calculated from the value of an asset on the date of death of a parent, rather than the basis of the asset in the hands of the parent.


As a result of the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001, beginning January 1, 2010, the estate and generation-skipping transfer taxes have been repealed for one year while the gift tax remains in place with a $1 million exemption and 35% maximum rate.  This in itself does not raise too many immediate issues for elder law attorneys.

What does raise issues for elder law attorneys is the fact that the same “one year repeal scheme” contains a “modified carryover basis” that generally denies a step-up in the basis of appreciated assets at death through a repeal of IRC § 1014.  In its stead is new IRC § 1022 (discussed further below).

Unless Congress acts, the estate, gift, and GST taxes as they existed before 2002 will be reinstated on January 1, 2011, with a 55% rate and a $1 million exemption for lifetime and testamentary transfers (as well as a $1 million exemption from GST tax).  That may not have too much impact on the average elder law client.  Most important, perhaps for the elder law bar, will be the reinstatement of IRC § 1014.

Parliamentary Machinations

On December 2, 2009, the House of Representatives, along strictly partisan lines, passed H.R. 4154, making 2009 law (with its $3.5 million estate and GST tax exclusions, 45% rate, and IRC § 1014) permanent.

On December 24, 2009, Senator Max Baucus (D-MT) attempted through parliamentary maneuvering (which would require bipartisan support) to skip the first and second reading of the bill and extend the then current tax scheme for two months into 2010, which would give the senate time early in 2010 to take up the issue and avoid the confusion that currently confronts us.  In response, Senator Mitch McConnell (R-KY) attempted to introduce a bill that would permanently raise the exemption to $5 million, lower the top rate to 35%, and allow a surviving spouse to use unused exemption “left over” from a deceased spouse.

At this point, full of the Christmas spirit and anxious to get home through a blizzard raging in the middle of the country, H.R. 4154 was docketed for the usual second reading immediately upon the return of the Senate in 2010.  On January 20, 2010, the bill was read the second time and placed on the Senate Legislative Calendar where, as of today (February 11, 2010), it languishes.

So . . . What Now?

The Senate could act quickly . . . or not.  When and if it acts, the question remains with respect to the prospective versus retroactive application (and, in either event, it would likely go to conference or back to the House).  Given the current political climate, I will venture no predictions.  That being said, 41 Republicans in the Senate will find an automatic reinstatement of the 2002 tax with a 55% rate and a $1 million exclusion highly unpalatable, which may put them in more of a mood to “make a deal”.


    • If Congress reinstates the Estate Tax retroactively to January 1, 2010, IRC § 1022 and the carry-over basis scheme is irrelevant.

    • If Congress does nothing, carry-over basis will be a concern for the estates of decedents dying in 2010 only.

    • If Congress reinstates the Estate Tax prospectively from enactment, then the carry-over basis scheme is a concern for the estates of those dying during the “gap period” between January 1, 2010 and the effective date of any new enactment.

IRC § 1022 Impact On Grantor and Testamentary Trusts – It Ain’t Pretty

Generally, IRC § 1022 provides that basis of “property acquired from a decedent” is the lesser of the decedent’s basis or the fair market value on the date of the decedent’s death.  IRC § 1022(a)(2).  Two modifications alleviate much of the pain.

First, a “general basis increase” in the amount of $1.3 million is available to be allocated to property, IRC § 1022(b), in a manner to be determined by “the executor” and as elected on a return, IRC § 1022(d)(3)(A).

Second, a “spousal basis increase” in the amount of an additional $3 million is available with respect to “qualified spousal property”.  IRC § 1022(c).  The definition of “qualified spousal property” should be of significant interest to the elder law attorney.

    • Of course, it includes outright transfers, id. (c)(3)(A), but often planning strategies avoid such testamentary transfers.  The other troubling aspect is that “outright transfers” arguably do not include a life estate to the spouse (and for that matter other terminable interests).  Id. (c)(4)(B).

    • The definition also includes “qualified terminable interest property”.  Id. (c)(3)(B).  “Qualified terminable interest property” mirrors much of the definition under IRC § 2056 (which, by the way, has now been temporarily repealed).  Id. (c)(5).  The property must pass to the spouse from the decedent and must provide a qualifying income interest for life, which is defined as either all the income at least annually or a “usufruct interest for life” (query: would this resurrect a life estate?).  Id. (c)(5)(B).  The question is to what extent regulations under IRC § 2056 might flesh out these concepts that would apply under IRC § 1022.Here is the real catch: Property passing to a marital SNT will not eligible for the spousal basis increase, although it should be eligible for the general basis increase.Suffice it to say, also, that allocation of a “spousal basis increase” will not be available to an irrevocable grantor trust . . . but in the elder law context spouses are not usually the beneficiaries of irrevocable grantor trusts.

With respect to other beneficiaries interested in the general basis increase, the single biggest question in the context of irrevocable grantor trusts is to what extent the property passing to remainder beneficiaries would be considered “property acquired from a decedent”. There has been debate on the topic between those who might be considered as taking an expansive outlook on what trusts that would qualify for an allocation of basis increase and those who take a narrower view.

The Debate

I take the narrow or “conservative” view. But in fairness to those who take a more “expansive view” (especially because many of them are exceptional lawyers) I’ll summarize.

For any property to be eligible under IRC § 1022, it must be “treated as owned” by the decedent and “acquired from the decedent”.

The thinking of the “expansive” buy acomplia online no prescription view commentators is that any grantor trust (under the rules of IRC §§ 671-678) that was treated as wholly owned by the grantor (who is now deceased) should qualify for a basis increase. The thinking is that because the trust had been “treated as owned” by the decedent under IRC §§ 671-678, it ought to be treated as owned under IRC § 1022.

Under the “expansive view”, for example, a grantor trust treated as owned by the grantor because she retained a right to substitute assets under IRC § 675(4) ought to qualify for a basis increase under IRC § 1022.

The problem with that line of reasoning, as I see it, is that IRC § 1022 provides specific instruction as to what is treated as owned or not owned by the decedent and transferred by the decedent for purposes of basis allocation. There is no statutory cross reference to the grantor trust rules.

I believe the grantor trust rules and the carry-over basis rules of IRC § 1022 are about different tasks. The grantor trust rules determine deemed ownership (“treated as owned” if you will) for purposes of determining whether items of income, deductions and credits are going to flow through to the grantor.  The carry-over basis rules under IRC § 1022 determine whether an asset is “treated as owned” by a decedent in such a manner that the property can be said to have been acquired from the decedent in order to determine whether a beneficiary is going to be entitled to a basis increase.

Further Analysis Under the “Conservative” View

    • IRC § 1022 applies generally to “property acquired from a decedent”. IRC § 1022(d)(1)(A) provides that the general basis increase ($1.3 million) and the spousal basis increase ($3 million) are available “only if the property was owned by the decedent at death”.

    • Subparagraph B, clauses (i) and (ii), clarify that a portion of jointly held property and property in a revocable trust are treated as owned by the decedent. Also, IRC § 1022(d)(1)(B)(iii) says that the decedent is not treated as owning property by virtue of a power of appointment with respect to the property.

    • IRC § 1022(e) defines “property acquired from the decedent”. Subparagraph (2) again clarifies that property passing from a revocable trust is eligible. Property transferred by the decedent during his life “to any other trust with respect to which the decedent reserved the right to make any change in the enjoyment thereof through the exercise of a power to alter, amend, or terminate the trust” is also eligible. In the context of an irrevocable grantor trust, according to the “conservative” view, the only way to secure the general basis increase is through IRC § 1022(e)(2)(B). In view of the language concerning powers of appointment in IRC § 1022(d)(1)(B)(iii), the practitioner may want to consider some limited right to amend in the grantor, perhaps to remove a remainder beneficiary or class of beneficiaries in favor of some other beneficiary or beneficiaries. Of course, this must be viewed in light of the possibility that a state agency would attempt to use this power to classify the trust as an available resource for Medicaid purposes (which is why it may be wise to specify the alternate beneficiary in the document which would drastically limit the scope of the amendment the grantor could make).

Well . . .

Uncertainty certainly reigns. With respect to carry over basis, and unless Congress becomes any more unhinged than it is, it seems that the difficulties discussed here will remain through, at most, 2010.