Skip to main content

Dolina Hobbs, LLC
82 W Washington St, Suite 200, Hagerstown, MD 21740 [Map]
Call (301) 739-1013 / (877) 739-1013  •  Fax (301) 739-6432

You are here

Congress Cracks Down On Inheritors' Tax Loophole - Forbes

There’s a dirty secret that when selling inherited property, some beneficiaries overstate the original value of it on their income tax returns to lessen the tax hit. That’s long irked the Internal Revenue Service, and a new law tucked into the summer’s highway bill cracks down on the practice. Although executors and beneficiaries of estates with tax returns filed after July 31, 2015 have to mind the new law, they’re still stuck waiting for Internal Revenue Service guidance on exactly what to do by a February 29, 2016 deadline.

How much “cheating” is going on? The new basis consistency and reporting requirements are estimated to bring in an additional $1.5 billion to the Treasury over the next 10 years. “The IRS knew it was going on, and they wanted to close it,” says Todd Steinberg, an estate lawyer with Greenberg Traurig in McLean, Va.

Via a “step-up in basis,” appreciation on assets held at death escapes income tax, but any appreciation after that gets hit with a federal capital gains tax of up to 23.8% when you sell the asset. Before the new law, beneficiaries weren’t tied to the value the estate put on an asset; they could ignore it and argue for a different value, says Steinberg. That meant potentially huge tax savings in the case of hard-to-value assets like real estate and privately-held businesses. For rich people taking advantage of this wiggle-room, the crackdown is a big deal.

Penalties could be significant. Under the new law, effective for estate returns filed after July 31, 2015 (taxable or not), executors have a new duty to report to the beneficiaries—and the IRS—the value of specific assets on the estate tax return. In the case of taxable estates, the beneficiaries are then tied to the value the estate puts on an asset—or they face a 20% penalty applied to the underpayment due to the inconsistent basis position. The fear of that penalty should force compliance, says Andrew Katzenstein, an estate lawyer with Proskauer in Los Angeles. The penalty for an executor who fails to file the information reports is a mere $250.

Bizarrely, you might be a beneficiary and get one of these reporting forms and not be bound by it. That’s because an estate tax return might be filed to elect portability (that lets a surviving spouse carry over any unused portion of the first spouse to die’s estate tax exemption) and no tax would be due. And on the flip side, you might want to file an estate tax return as a “sword against the IRS” says Steinberg, just to prove the income tax basis of a hard-to-value asset.

There’s a natural tension in almost every big estate. You want to value the assets low to avoid estate tax (for 2016, the federal estate tax exemption is $5.45 million per person), but beneficiaries want to value the assets high to avoid capital gains taxes when the time comes to sell. What makes this trickier: When it’s a hard-to-value asset, there’s a reasonable range of acceptable values, and appraisers will work with you to get at the high end or low end of that range depending what you want to accomplish, says Katzenstein.

Click here to read the full article by Ashlea Eberling.