Starting in 2010, a system called "carryover basis" replaces today's "stepped-up basis" for property that passes to another person after a decedent's death. This minimizes the "good tax result" following a person's death. This "system" is essentially a replacement to the estate tax, as it is a modified income tax system of taxing assets of a decedent.
The carry over basis system means, a decedent's heirs or devisees who sell property they inherit from the decedent, will have the same amount of taxable gain that would have resulted if the decedent had sold the property. However, every estate (except for estates of nonresident aliens) will be entitled to increase, by a maximum of $1,300,000, the basis of assets to the date-of-death value of the assets of a decedent's estate. Thus, if the decedent's estate has noncash property worth $6,000,000 on the date of death, having an adjusted basis of $1,000,000, using this limited, modified basis step-up provision, the basis of this property can be increased to $2,300,000. If a surviving spouse receives the assets, an additional $3,000,000 in basis step-up is available.
Planning pitfalls and opportunities exist in the allocation of the $1,300,000 basis increase. For instance, who receives the basis increase and which assets receive the step-up in basis? Who keeps track? The IRS? We don't think so.
The bad news: The beneficiaries of an estate of a single person worth $3,500,000 or less may be worse off, after the exemption increase to $5,000,000 tax, than before. Before 2010, the estate would pay no estate tax and the estate's assets would pass to heirs and devisees with a full basis step-up. For 2011 and 2012, the estate will pay no estate tax unless the estate exceeds $5,000,000, but the heirs and devisees' step-up will be limited to actual basis plus $1,300,000. So, a decedent basis may be worse off under this new scheme, as the estate tax is replaced with a vibrant new source of income tax.
