Estate Tax Proposal is a Winner

By Chris Hesse, CPA

At this writing, Congress has not yet passed the Tax Relief Act of 2010, the compromise legislation drafted by Sens. Reid and McConnell. Included in the legislation is language temporarily increasing the estate tax exemption (through 2012) while decreasing the estate tax rate.

The proposal re-imposes the estate tax back to January 1, 2010 with a $5 million effective exemption per person, or $10 million per couple. The rate on estate value in excess of $5 million is 35%. To eliminate the concerns with a challenge to a retroactive imposition of a new tax, Congress is allowing the personal representative to elect to use the 2010 law which had repealed the estate tax. Why would executors choose not to make the election? Estates with values less than $5 million would desire to use the proposed legislation in order to obtain a fresh start on the tax basis. For farmers, this is a big win.

When a person inherits property from a decedent, the property usually has a tax basis for depreciation and sale purposes equal to the fair market value of the property at the date of death. (There are exceptions too technical to discuss here.) For example, if the value of wheat in the bin is $6.00 per bushel at the date of death, and the heir sells the wheat for $6.10 per bushel, the taxable income is only 10 cents per bushel. (Had the decedent sold the wheat the day before death, income of $6.00 per bushel would have been realized.) “Step-up” in tax basis is very important for farmers.

The 2010 repeal law has a limited “step-up.” (Although it is common to refer to the fresh start as a “step-up” in tax basis, it is important to note that basis could be stepped down if the property fair market value is less than the decedent’s tax basis.) The decedent’s assets get a “free” adjustment of up to $1.3 million. An additional $3.0 million is allowed if property is passed to the surviving spouse.

Under the proposed legislation, the unused portion of the $5 million exemption is allowed to pass to the surviving spouse. We refer to this as “portability.” This provides married couples with a true $10 million joint exemption, if properly handled in the estate. Under the historic estate tax, complicated trusts and planning were necessary in order to allow both spouses to use the maximum exemption.

The state of Washington’s estate tax law is unchanged. The exemption for Washington estates is $2 million, and has no portability provision. If the estate of the first spouse to die is less than $2 million, the excess does not pass to the surviving spouse. Washington has a provision favorable to farmers, however. If the estate meets stringent tests, farm property is excluded from the measure of tax. Generally, this requires the decedent to have materially participated in the farm. In addition, more than 50% of the estate value needs to include farm assets.

The above is very general in nature and must not be relied upon for planning purposes. To learn more about estate taxes, attend one of the Washington Farm Bureau’s presentations on “Bridging the Generations.” Go to www.wsfb.com for more information.

Pursuant to Internal Revenue Service Circular No. 230, be advised that the above information is not intended or written to be used, and it cannot be used by the taxpayer, for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on the taxpayer.

Chris Hesse, CPA is a Principal with LarsonAllen. He is a former president of the Grant County Farm Bureau. He can be reached at chesse@larsonallen.com