Tuesday, March 23, 2010

Unexpected tax results form Congress letting Estate Tax Expire even for those who are not rich

As of January 1, 2010, unless Congress intervenes, IRC Sec. 1022 replaces the step-up rules of IRC Sec. 1014 and totally changes the rules for what property is eligible for basis increases at death. New Sec. 1022(d)(1)(B)(iii) clearly provides that a “decedent shall not be treated as owning any property by reason of holding a power of appointment with respect to such property.”
 
What this means for our VA planning clients is that a  (non-grantor) irrevocable trust with a testamenatry right to change beneficiaries that had previously been used in VA cases to provide a step-up in basis at the grantor’s death, will no longer provide such a step-up in basis.

We are now clearly caught between the devil and deep blue sea. Either make the trust a grantor trust with income reportable to the person receiving VA disability pension or don't get a stepped-up basis in assets at death. There is no law that prohibits VA receipients from forming grantor trusts but since the VA annually checks what we report as income with our tax retrurns they will naturally want to know why we did not report all the income earned by the grantor trust. Given the VA's very limited understanding of trusts (they have only ruled on approximately 1/2 dozen trusts) we have, herebefore, avoided having to explain that the Va receipient is taxed on the income but prevented from ever receiving it by trust law. The VA adjudicator's head would undoubetedly spin so fast it would separate from his body if he tried to understand the intricaicies of trust taxation that escapes most lawyers and accountants unless they have a masters in tax and have engaged in a great deal of study.

To complicate the problem further, It is still unclear as to whether an irrevocable "grantor trust" will provide a step-up, either.  Many scholars believe it will not. If this is truse then our Medicaid planning clinets that do have "grantor trusts" will also not receive a step up in tax basis at death.
 
We are continuing to monitor what Congress is doing with regard to this issue, however, I felt it was important to alert you immediately as to the change in law. Congress' retroactive reinstatement of the estate tax will fix this problem and get us back on course but who knows what this Congress will do next.