• Under the default rules, the estate would pay a 35 percent estate tax on assets that exceed the $5 million exemption and the beneficiaries would take a stepped-up basis in the property; or
• The personal representative could elect to pay no estate tax, but would forfeit the full basis step-up.  Instead, the estate would be able to step up basis of up to $3 million for property left to a spouse and $1.3 million for property left to anyone.

In other words, executors had to choose between applying the prior law, which repealed the estate tax and introduced a modified carry-over basis system, and the new law, which reinstated the estate tax and returned to a stepped-up basis system.

We noted at the time that this election would add complexity (and liability) for tax return preparers, attorneys, and other financial advisors involved in administering the estates of decedents who died in 2010.  We have seen a few of these issues come to fruition over the past year.

Cost Basis Determination and Allocation

The modified carryover basis system introduced by EGTRRA did away with the unlimited step-up in basis in property inherited from a decedent in 2010.  Instead, taxpayers would take a “carryover” basis equal to the lesser of the decedent’s adjusted basis or the fair market value on decedent’s date of death.  There were two notable exceptions to this rule:

• Each taxpayer received $1.3 million ($60,000 for non-resident non-citizens) of basis increase that can be allocated among his or her assets at death; and
• Each taxpayer received a $3 million basis increase for qualified spousal property.

This means that executors that elect for EGTRRA to apply must both determine the decedent’s basis in assets and allocate the basis increases among the decedent’s assets.  As expected, this has proven to be challenging.  In many cases, the decedent’s primary capital assets have been owned for decades.  The decedent’s acquisition costs and the value of various capital improvements have not always been well-documented.  This leaves executors with the task of reconstructing the financial history of the decedent’s assets with very little to go on.

Executors also have to decide how to allocate the basis increases among the decedent’s assets.  To do this, executors must determine when the assets are most likely to be sold and allocate the basis in a way that will achieve the optimum tax result.  This places a significant burden on executors by requiring judgment calls that are often based on incomplete information.

IRS Guidance and (Finally) Form 8939

Midway through the year, the IRS published Revenue Procedure 2011-41, which gives personal representatives safe harbor guidance on basis allocation.  Under the Revenue Procedure, the $1.3 million and $3 million basis step-ups can be increased by the amount of the decedent’s unused net operating loss and capital loss carryovers.  If the decedent owned loss assets (assets worth less than their basis), the amount of the loss can also be added to the basis step up.

The Revenue Procedure also provides that when a beneficiary allocates basis to a depreciable asset, the added basis is treated as though it were part of a new asset that was first placed in use on the decedent’s death.

Personal representatives were required to report basis allocations by November 15.  The IRS released a draft form for this purposes (Form 8939) early in the year, but was slow to release a final version.  Although the IRS stated that the form would not be due until 90 days after it was first issued, practitioners worried that the form would inject further complication into the situation.  A few weeks before the November 15 deadline, the IRS extended the Form 8939 due date to January 17, 2012.  A few weeks later, the IRS released the final Form 8939.  Thankfully, form is straightforward and doesn’t introduce unexpected complications.  You can view the form here.

Seating is limited and will be on a first come, first serve basis.  Please RSVP by January 31, 2011, to reserve your seat.  You can RSVP by contacting David Jones or Jeramie Fortenberry.

Jeramie J. Fortenberry has has been selected by the Mississippi Business Journal as one of Mississippi’s Top 50 Attorneys for Leadership in Law “Class of 2010.”  The selection was made from a large pool of highly qualified nominees. The award is intended to honor the state’s most successful lawyers, taking into account both legal success and qualities of character that make only a few stand  out.

The awards dinner is Thursday, November 4 at 6:00 p.m. at The Hilton Jackson.  The Mississippi Business Journal will publish a special edition on November 22, 2010, to honor the recipients of this designation.

The 2010 Mississippi law update will cover ten substantive practice areas. Other speakers include Professor Ron Rychlak, Professor Hans Sinha, Alan Perry, Mike Malouf, Whit Rayner, Rick Patt, Tom Hood, Alison Vance, and Clarence Guthrie. More information is available here.

Fortenberry’s sub-group will be responsible for making policy recommendations for Domestic Asset Protection Trusts.  DAPTs were first recognized in 1997 when Alaska enacted the first DAPT statute.  Until then, asset protection trusts were only available in foreign jurisdictions, where they attracted American dollars.  Once Alaska took the first step, other states quickly followed suit.  In just 10 short years, ten other states had enacted some form of DAPT.  States with some form of DAPT now include Alaska (1997), Delaware (1997), Nevada (1999), New Hampshire (2009), Rhode Island (1999), Utah (2003), Missouri (2004), Oklahoma (2004), South Dakota (2005), Tennessee (2007), and Wyoming (2007).

It has long been recognized that a person is free to include a spendthrift clause in a trust instrument that prohibits the beneficiary from transferring, assigning, or otherwise alienating his or her right to future payments of income or principal. This means that if the beneficiary is unable to pay a debt, the creditor will be unable to access trust assets to satisfy the debt (or even to collect upon a judgment) until those assets are paid to the beneficiary.

But this general rule assumes that the person who established the trust (the settlor) is not also the beneficiary.  In other words, the asset protection works only if the beneficiary is someone other than the trust creator.  DAPTs are a departure from this traditional rule in that they allow the trust creator to fund a trust for his or her own benefit and still shield the trust assets from creditors.

DAPTs are typically subject to exceptions to protect against situations that would violate public policy. For example, many DAPT statutes provide exceptions for transfers to DAPTs that are made in anticipation of insolvency or otherwise to defraud creditors (usually as determined under the Uniform Fraudulent Transfers Act).  Other common exceptions include domestic claims such as alimony or child support and, less commonly, tort claims.

Fortenberry will work with the other members of the Asset Protection Sub-Group to review legislation from other jurisdictions and make policy recommendations regarding Mississippi’s adoption of DAPT legislation.

The Trust Laws Study Group, which will work under the guidance of the Policy & Research Division, is responsible for reviewing and updating Mississippi’s business laws and other laws related to the Secretary of State’s mission. The Trust Laws Study Group is composed of business professionals, attorneys, CPAs and members of the state legislature and judiciary, among others.

The purpose of the Trust Law Study Group is to study the area of Trust law and make recommendations on various policy proposals to the Mississippi legislature.  The Secretary of State’s Policy & Research Division will then prepare proposed legislation based on the Trust Law Study Group’s recommendations and meet with state legislators to educate them on the proposals, with a goal of adopting the proposals as Mississippi law.