Article on Basis Harvesting

Terence S. Nunan (attorney, Los Angeles, CA) recently published his article entitled Basis Harvesting, Probate & Property (September/October 2011). Excerpts from the article are below:

Formula marital deduction provisions have been used for many years to eliminate the estate tax on the first spouse’s death….Such formula provisions have had the practical effect of discouraging IRS audits of estate tax returns because no estate tax will be due even if the values of estate assets are increased on audit, but most practitioners, and apparently the IRS, believe that formula marital deduction provisions are valid for the federal estate tax. It is difficult to identify a principled distinction between a formula marital deduction provision to eliminate estate tax and a formula basis harvesting provision to eliminate or diminish income tax.

…Given the language of IRC § 2041, which speaks in terms of “any property,” it would seem clear that a selective granting of power of appointment to particular items of property, but not other property, held in a trust should be effective for estate tax and income tax purposes. In addition to including a basis harvesting provision in new estate planning documents, it may be possible, with court approval, to add a basis harvesting provision to pre-existing trust to use the otherwise wasted estate tax exclusion of the surviving spouse who is the beneficiary of such bypass trust.

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If implemented in a timely manner, a basis harvesting provision could permit the heirs of most married couples to reap significant income tax savings.