A couple of changes quietly crept into the law recently. They are major estate planning events for some estates and executors.
Congress passed and the President signed a temporary extension of the highway trust fund in late July. The law contains a few tax provisions designed to raise some revenue, and one of those changes affects estate planning and beneficiaries.
When property is inherited, heirs usually can increase the tax basis to its fair market value on the date of the previous owner’s death. This allows all appreciation during the previous owner’s period of ownership to escape capital gains taxes, though it might be subject to estate taxes.
The estate executor compiles an inventory of all property owned by the decedent and values the property. The property is included on the estate tax return (if it is required to file one), at its fair market value on the date of the decedent’s passing.
The IRS believes beneficiaries often inflate the basis of inherited property when they sell it. When computing capital gains taxes, the heirs assign a tax basis to the property that is higher than what the estate used to value the property.
To prevent this, the law now requires estates to file information returns with the IRS and beneficiaries. The information returns will include descriptions of the property and the value reported on the estate tax return. The estate will be penalized for failing to file such returns. Also, the beneficiary will be subject to a 20% accuracy-related penalty if he or she is caught selling an asset and reporting a basis higher than what the estate reported.
Pending the release of IRS regulations it appears that only estates that file estate tax returns have to file the information returns. But to take advantage of the transfer of an unused lifetime exemption from one spouse to another (the portability rule), an estate has to file a return even if it isn’t required to. So, it could be that most estates also will have to file these information reports.
In another change that affects estate planning, the IRS no longer will automatically mail closing letters to executors of estates. In the past, the IRS routinely issued these letters stating that the estate tax return was received and that it either is accepted as filed or that there’s been an audit and both sides agreed to the changes.
Smart executors often wait until such letters are received before distributing an estate. That’s because beneficiaries will be personally liable for unpaid taxes if the estate is distributed before taxes are settled. For some taxes and debts an executor can be personally liable if property prematurely is distributed from an estate.
The IRS still will issue the closing letters. But the executor has to ask for one, and the IRS suggests waiting until at least four months after an estate tax return is filed before requesting the letter.