David P. Johnson

The scheduled repeal of the estate tax for one year beginning January 1, 2010 is here, unless retroactively reinstated.  Also, under a sunset provision of the 2001 tax act, as of January 1, 2011, the estate tax exemption will become $1,000,000 with a maximum rate of 55%.

No one knows with certainty what Congress will do to remedy this situation.  Some have stated that they will attempt to pass estate tax legislation in early 2010 and make such legislation retroactive to January 1, 2010. Others note that it may be in the best political interests of both parties to do nothing and let the 2001 tax act sunset.

In 2010, the estate tax is replaced by a modified carryover basis system. Assets owned at death have generally received a basis step up to fair market value at date of death. In 2010, a beneficiary receives property with an adjusted basis equal to the lesser of the decedent’s basis or the fair market value at death. To offset the loss of the step-up, one may allocate a $1,300,000 aggregate basis increase on an asset-by-asset basis up to its fair market value at date of death.  Unless one can prove otherwise, the IRS presumes that an asset has a basis equal to its approximate FMV when acquired by its last owner.  Therefore, it is important to keep adequate records for assets.

Many estate plans did not anticipate the lack of estate tax and the carryover basis, and plans should contain enough flexibility to accomplish desired goals under changing circumstances.

    If taxpayers (other than married filing separately) have adjusted gross income (AGI) that is not more than $100,000, they can convert the money in a regular IRA to a Roth IRA, and they will not be required to pay the 10% penalty tax on premature distributions.  Income tax, however, must be paid on the conversion.

    The $100,000 AGI limtation will be repealed in the year 2010 under the Tax Increase Prevention and Reconciliation Act signed by President Bush in May 2006.  Taxpayers will also have the option to pay the income tax on conversions during 2010 over a two-year period.

    Distributions from one Roth IRA can be rolled over to another Roth IRA, without being subject to income tax.  Rollovers and conversions of traditional IRAs to Roth IRAs are subject to the 60-day rule for rollovers.  This means that an individual may convert to a Roth IRA by withdrawing funds from the traditional IRA up to December 31 and then roll the funds into the Roth IRA within 60 days.  Roth IRAs are also subject to the limit of one rollover per year that applies to traditional IRAs.

    A conversion to a Roth IRA may be reversed without penalty by transferring the funds and any earnings back to a traditional IRA before the due date for the tax return.  However a taxpayer must wait until the later of 30 days or the next year before reconverting to a Roth IRA.

    If a regular IRA is converted to a Roth IRA, any distributions will not be qualified until a 5-year period has run from the first year in which contributions or conversions were made to the Roth IRA. Nonqualifying distributions of the converted assetswill not be subject to income tax, but will be subject to the 10% penalty tax.   

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