IRS Silent So Far On New US Tax Rules For Inherited Wealth

Our trusts are drafted in such a way to account for the change, but still going to be an interesting time figuring it all out.

By Martin Vaughan, Of DOW JONES NEWSWIRES

WASHINGTON -(Dow Jones)- The U.S. Internal Revenue Service is taking a wait- and-see approach on issuing guidance dealing with taxes on inherited wealth, unsure whether Congress will act in the next several months to change the rules again.

Advisers to the wealthy say they are left without a roadmap on a number of issues related to the disposition of assets left behind by those who have died since Jan. 1. In particular, they are looking to IRS for rules on how a new capital gains-tax regime that took effect this year will apply to estates.

"There are no forms that give us any idea how or what we are supposed to report," said Stephen Litman, an estate planner at the Minneapolis law firm of Leonard, Street and Deinard. "This leads to significant administrative challenges for families."

Congress is weighing whether to set permanent rules for taxing estates, and whether to make those rules retroactive to the beginning of this year, but such action is weeks, and maybe even months, away.

The 2001 tax-cut law was aimed at gradually eliminating estate taxes, but repeal proponents at the time lacked the congressional majorities needed to do so permanently.

As a result, the federal estate tax was repealed for 2010 only, and is scheduled to return in 2011 at rates similar to those in effect prior to President George W. Bush's tax cut legislation.

In place of the estate tax for 2010 is a capital gains tax that is levied when assets are sold. Heirs would have to pay capital gains taxes on the full appreciation in value of the asset from the time it was acquired by the deceased benefactor, a concept known in tax circles as "carryover basis."

That means that families have an additional step of searching records to establish the basis value of the asset, which was unnecessary when estate taxes were in place.

"Carryover basis rules have added another level of complexity," said Carol Kroch, head of wealth and financial planning at Wilmington Trust Corp. "Families will have to go through a more difficult process of valuing assets."

The 2010 law provides that heirs can get a "step-up" in basis, meaning no capital gains taxes would be due if the asset is immediately sold, for up to $ 1.3 million of the estate property. Surviving spouses can get a step-up in basis for an additional $3 million in property.

Families will have to decide which assets to protect from capital gains taxes with the basis step-up. For example, property that is to be sold in the near future might be a good candidate, to avoid an immediate tax consequence. It might also be wise to protect property that has been in the family for a long time, and therefore has a low basis, wealth advisors say.

All that said, Congress might pass legislation that reinstates the estate tax for 2010 and eliminates the carry-over basis rules, which would make all such planning moot.

That may explain why IRS for now is waiting for the legislative picture to come into focus.

"We are currently looking at the issues involved to determine the best course of action," said IRS spokesman Bruce Friedland.

Families generally have nine months from the death of the estate owner to file estate tax returns, so there is a little breathing room before they have to make decisions about how to allocate assets.

"I don't think anyone would be distributing assets yet," said Kroch. "Over time, estate executors will have to make a decision about how much to hold in reserve for the estate tax" in case Congress re-imposes it retroactively, she said.

Another option that is getting some discussion by congressional staff is an election that would allow the family members of people who died between Jan. 1, 2010 and when new legislation takes effect to choose between paying estate taxes, for example at the rates in effect in 2009, or the capital gains-tax regime under the current law.