Wednesday, September 14, 2011

IRS Extends Key Deadline For 2010 Heirs (BLOG)


If you're an executor for someone who died in 2010, mark your calendar for Jan. 17, 2012. That's the new date by which you must now file a key federal tax form.
In a issued today, the IRS announced the deadline for submitting the Form 8939, which was previously due on November 15, 2011. But there's still one missing detail: the IRS has yet to issue the form.
This is but the latest installment in the bureaucratic chaos that has surrounded the administration of 2010 estates. It stems partly from the new tax law that President Obama signed last December. Under this law, the executor (the person or institution that is in charge of administering an estate) of someone who died in 2010 must chose whether the estate will be subject to the law that was in effect for most of 2010 or subject to the new law.
What's the difference? Under the new law, which applies to all those dying in 2011 and 2012, each person can pass up to $5 million at death tax-free to non-spouse heirs. Above that $5 million, there's a 35% estate tax, as well a second extra layer of tax (known as the generation-skipping transfer tax) for bequests to grandkids whose parents are still alive.
But significantly, the cost basis of all assets in the estate gets adjusted or "stepped up" to their fair market value as of the date of the late owner's death--meaning inheritors can sell all the assets right away without owing any capital gains tax. This step up in basis applied in 2009 and before too. Apart from the tax benefits, it has always been considered a way to limit the administrative burden on executors and heirs.
By contrast, under the law in effect for most of 2010, someone could pass on an unlimited amount without an estate or generation-skipping transfer tax applying. But when heirs sell those assets, they have to use the original price paid for the assets (known as "carryover basis") to compute the capital gains taxes owed. That's the general rule. Each estate, however, is eligible to exempt up to $1.3 million of gains on assets left to non-spouse heirs from this carryover basis rule. Another $3 million exemption applies to appreciated assets left to a spouse.
Confused? When all is said and done, most estates worth $5 million or less will be better off under the new estate-tax regime, while those worth more than that may prefer to use the 2010 law. But many families will need to hire tax advisers to verify that by crunching the numbers.
Now families have until Jan. 17 to make up their minds and indicate their preference on Form 8939, Allocation of Increase in Basis for Property Acquired From a Decedent. This is the second time the Service has extended the deadline for filing the form.
The other key tax form that some families need to think about is Form 706, the federal estate and generation-skipping tax return. Executors must file either Form 706 (to remain in the default estate tax regime) or Form 8939 (to opt out of the estate tax).
With Form 706, too, the IRS had been dragging its feet, but finally issued the form and instructions on Sept. 8, as my colleague Hani Sarji explained . Form 706 is due Sept. 19, but families can get an automatic a six-month extension— both to file Form 706 and pay the tax due — if they file Form 4768 by that date. (In other years, you would generally have to give a reason for extending the time to pay the tax.) However, today's notice indicates that "interest will accrue on the estate tax liability from the due date of the return, excluding extensions."
So let's say you're the executor of a 2010 estate. What do you do next?
Have assets appraised
With either approach, as in past years, unless the date of death value of a costly asset is obvious (as it is for publicly traded securities, for example), the executor will need to start by getting an appraisal of the asset.
If you apply the new estate tax law, you need the appraisal information both to figure the total value of the estate and to compute capital gains when heirs hold onto the asset and later sell it.
If an estate elects to use the 2010 law, with the modified carryover basis system, the date of death appraisals are needed for a different reason. Subject to certain limitations, if an asset is worth more when someone dies than she paid for it, her estate can apply the $1.3 million/$3 million in allowed basis adjustment to the difference. If the gains in an estate are greater than those amounts, there might be income tax owed, but it's not triggered and doesn't have to be paid until the asset is sold.
Here's an example of how the 2010 law works. Let's say you inherit publicly traded stock from your mother. If she bought it for $500,000 and it's worth $2 million when she dies, there's $1.5 million of appreciation, or what tax geeks call "built in" or "unrealized" gain. Without a basis adjustment, if you immediately sold the stock, carryover basis rules would require you to pay tax on that $1.5 million gain. But instead the law allows you to bump the basis up by $1.3 million, so it's as if the stock cost $1.8 million ($1.3 million plus $500,000) instead. When you sell it, assuming the value hasn't changed since Mom died, you would pay capital gains tax on $200,000 ($2 million minus $1.8 million).
Locate purchase records
If you can't prove what assets originally cost, the IRS assumes the cost is zero and could try to saddle you with capital gains tax on the total sales amount.
With investments like Mom's stock, old brokerage statements can often help you determine the original cost of shares. But if the assets have been moved between financial institutions, the purchase date--let alone the original price--might not be on file with the current broker. What can you do in such cases? Accountants believe it will be acceptable to estimate an asset purchase date and then obtain price information directly from public companies or by checking newspaper archives or basis services available on the Web.
Real estate can pose a much bigger problem. Consider a home that has been in the family for many years. Basis consists not only of the purchase price, but also the cost of capital improvements that add value to the home. To re-create those records, you might need to scour grandma's attic for canceled checks showing what she spent to renovate the kitchen or add dormers to the country house, for example.
Cope with the new paperwork
Whatever Form8939  emerges is likely to ask executors to list each asset, along with its basis and date of death value. They will also need to indicate which assets the $1.3 million/$3 million in basis step-up will be applied to, and in each case how much the basis will get bumped up. There's no need to sell the asset before filing this form; what you're allocating is built-in gain between the original cost of the asset and the date of death value.
Certain limitations apply. For example, there is no basis adjustment on what is called income in respect of a decedent, or IRD. This is income that wasn't taxed before a person's death and would have been taxed if the individual had lived long enough to receive it. Examples include traditional individual retirement accounts, qualified retirement plans such as 401(k)s, a company bonus, income from an S corporation and money owed on a promissory note under an installment sale.
Also keep in mind that while the $1.3 million exemption can be applied to assets given to anyone, the $3 million exemption is limited to assets given exclusively to a spouse, either outright or in certain kinds of trusts. So you may not use this exemption if money is going into a trust that will benefit people in addition to the spouse.
Apply the basis allowance fairly
If some assets may be kept in the family, it's most efficient to allocate the basis to those that are likely to be sold first. But this strategy could cause some inheritors to benefit from the limited step-up in basis more than others. And that creates conflicts when an executor is also a beneficiary and allocating the basis a certain way would benefit herself.
This problem is analogous to one that has come up previously, when all assets were valued as of the date of death. Often several years pass before beneficiaries receive those assets. And meantime, values can fluctuate. When making in-kind distributions to beneficiaries (as opposed to handing out the proceeds of assets that have been sold), executors have always tried to give out assets that are not only roughly equal in value, but also have a roughly similar basis.
Guard against an executor's added risks




Legally, an executor is a fiduciary, who is expected to act prudently and be impartial. Under the best of circumstances, it can be a difficult job, with a risk of liability for missteps. Still, the complicated landscape this year, especially as it involves carryover basis, seems to leave an executor extra-vulnerable.

Executors can advise families that they are navigating uncharted waters, give reasons for any strategies they recommend and ask beneficiaries what they want to do. Along the way, it's wise to document conversations with follow-up correspondence and notes to the file.

If you're an executor and a family disagrees with your recommendations, it's best to do what they ask but get them to sign a document releasing you from liability and indemnifying you for losses. Such precautions are unusual–executors are expected (and often paid) to handle difficult situations. But in the current environment, you will probably feel more comfortable with this document in your back pocket.






forbes

No comments:

Post a Comment