The Oklahoman
By Cynda Ottaway
Dec. 10, 2010

In national, state and local elections, gridlock is often defined as a benefit of divided government. However, the failure of Congress to take action on the federal estate tax is a problem that needs to be fixed.

Recent media coverage of billionaires who died this year describes how their heirs are celebrating the lack of an estate tax. However, there is a hidden penalty that has not been widely discussed. If an unmarried individual dies this year, there will be no estate tax (subject to retroactive reinstatement), but there will also not be what is known as a “stepped-up” basis for income tax purposes. The trade-off for being subject to the estate tax system is that the decedent’s estate receives a clean slate with a brand new income tax basis. The assets can then be sold without paying any capital gains.

Last year, if you died with a company worth $3.5 million that had been started on a shoestring budget and therefore had a very low basis, you could have left the company to your heirs without estate tax. They would inherit the company with a new basis of $3.5 million and avoid any capital gains tax. Now, if the same scenario occurs in 2010, the heirs would receive the $3.5 million without any estate tax, but they would owe capital gains when the company is sold, which may come as a nasty surprise. There is an adjustment allowed on the first $1.4 million so the application of the rules will vary based on each individual’s situation.

In addition, the 2010 basis rules will require you to locate the original cost of each asset. The estate must list every asset and disclose its cost basis, even if it was acquired 50 years ago by a grandparent of decedent. The administrative nightmare of trying to determine this “carry-over basis” will be quickly felt by anyone who must report on a 2010 death. Congress tried this carry-over basis concept in 1978 and wisely discarded it when confronted with the uproar from financial institutions and tax professionals.

There is an easy solution. For any estate of a person dying in 2010, let the estate choose which law it wants to apply. If estate tax is a bigger issue for the decedent’s family, choose the 2010 law. If estate tax is not an issue, then choose the 2009 law and avoid the income tax problem.

Remember, the fact that there is no estate tax does not mean there is no tax. In fact, the death of a relative in 2010 could actually increase the overall amount of tax owed. Congress needs to act quickly to avoid costly surprise expenses for families of the deceased in 2010.