As many of you know, the estate tax was eliminated for 2010.  But there are still filing requirements – some new ones for 2010.  What many of you may not know is that there are two different types of estate tax returns – (1) the estate tax return which has been eliminated in 2010; and, (2) the estate income tax return which was NOT eliminated in 2010.  

There are significant differences between estate tax returns and estate income tax returns.  The estate tax return reports the gross amount of the estate. The estate income tax return reports the income from the gross estate for a specific period of time.  For example, an estate may have as the only asset $10 million of stocks and bonds; and, during the first year after death, the estate had interest and dividend income of $250,000 on the stocks and bonds.  Before January 1, 2010 the estate would have been required to file both an estate tax return on the gross asset of $10 million and an estate income tax return on the $250,000 of income.  In 2010 the estate tax return is gone but the estate income tax return is still required.

Another wrinkle in the estate tax for 2010 is that although there are no “estate taxes” that need to be paid, there are still filing requirements. These new requirements are more stringent than the 2009 filing requirements, i.e. more estates will be required to file the returns.  Also, failure to file will have hefty penalties and potential adverse income tax effects for the       beneficiaries of the estate. The forms have not yet been released by the IRS and the filing due date is April 15, 2011.

The new forms are required as the full step-up in basis is not available this year.  A step-up or step-down in basis has been part of the estate law for decades. Basically assets held on the date of death took the fair market value (the step-up or step-down) on the date of death for calculation of gain or loss. 

During our lifetime we may buy and sell stocks – and gain or loss is calculated from the purchase price. If we buy a stock for $25 and sell it for $75, we will report a gain at the time of sale of $50 and pay taxes on the $50. But if you died when the stock had a fair market value of $60 and the purchase price was $25, the gain would be calculated from the step-up basis of $60.  There the taxable gain would be $15, the difference between the date of death value and the sale price. 

The good news about the 2010 law is the step-down in basis is gone.  The step-down in basis has been especially devastating in 2008 and 2009 during the wild fluctuations in stock prices.  Stocks that had been purchased for $25 were suddenly worth $5 on the date of death.  Estates and/or beneficiaries were required to calculate gain or loss from the $5 fair market value date of death value not the $25 of purchase price.  That is the good news for 2010 – but the not so good news - the complete step-up is not available.  A quantified step-up amount is available and the returns that must be filed delineate how the step-up will be applied.

The estate’s executor will be required to file the new forms and to identify the assets receiving the basis    step-up.  All estates receive $1.3 million dollars in step-up basis.

The estate’s executor will be required to file the new forms and to identify the assets receiving the basis step-up.  All estates receive $1.3 million dollars in    step-up basis. So if an individual purchased $3 million dollars of stocks and bonds with a fair market value on date of death of $10 million the beneficiaries would receive a basis to $4.3 million. It is up the executor to select the stocks within the portfolio which will get the step-up.

Surviving spouses have an additional step-up of $3 million dollars which can be allocated to property left outright to the spouse or in QTIP trusts.  These assets must also be identified by the executor (or personal representative) on the required tax forms.