- Written by: T. Steel Rose, CPA
The signing of the Jumpstart Our Business Startups Act (JOBS Act) in April of this year has put the spotlight on auditing. Startups raising between $100,000 and $500,000 must be reviewed by a CPA while startups raising between $500,000 and one million dollars are required to be audited by a CPA. To get an idea of how this will affect CPAs across the country, CPA Magazine sat down with Angie Moss, CPA, audit partner with Sanford, Baumeister & Frazier, (SBF) in Dallas, Texas, Don Pfluger, CPA, audit partner with Gallina in Rancho Cordova, California, and Mike Sharp, CPA, Director at Sharp & Cash, LLP (a pseudonym) in New York.
How did you get involved in auditing and what do you like about it?
Moss: Well, I was hired off campus to join KPMG from the University of Texas Arlington.
Pfluger: After receiving a B.S. in Accounting from California State University, I started with Gallina 32 years ago. I originally wanted to be a lawyer, but I enjoyed accounting so I stuck with it. If there are technical issues they call me. I am also a practicing partner with assigned clients.
Sharp: My background is audit and tax because when you are dealing with entrepreneur companies, they may require an annual review and tax planning. I started with a larger firm, after graduating from college, and later moved to a boutique firm.
What is your experience with small firm audits?
Moss: I do a lot of audits of funds and broker/dealers who are required to be audited no matter what size they are.
Pfluger: We don’t audit publicly traded companies, we audit large and small firms [general building contractors, engineering contractors, specialty subcontractors, and suppliers]. One firm [we audited] has over $1 billion in revenue.
Sharp: For clients to raise capital on crowdfunding sites regulated by the SEC, these portals will put in safeguards on how companies can raise money, since technically they are not going public. The biggest criterion is the SEC wants to protect the small investor. Anyone with over $100,000 annual income can invest 10% of yearly income. If under $100,000, the investor can invest 5% of annual income or up to $2,000. There are three parts of the Act. One focuses on startups, another on accredited investors with over $1 million net worth, and the third part is that they are lifting the ban on advertising. Previously, when over 500 investors or $5,000,000 capital is raised you would have to register with the SEC. Now, you do not have to register until after you have over 2,000 investors.
For our firm, we will focus on startups and established companies who are looking to expand for these emerging growth companies. Certain sites will focus on different specialized areas.
How do you approach an audit engagement for a firm that has not yet been audited?
Moss: You really have to do some due diligence to determine the capabilities of how the accounting comes together.
It may be the owners themselves. You determine an approach around that. You may need to get some help for the client [to put their books in order]. They may have only kept cash books. Or you may be able to make audit adjustments. A lot of them, almost all of them, use QuickBooks.
Pfluger: They may not have any books. We may help them select their accounting system. It will be all along the gamut. They may have QuickBooks or they may be pure startups with no transaction history to speak of.
Sharp: Generally we are going to look for the purpose of the audited statements. They may have obtained a line of credit, and now they need the audit to maintain their covenants. You look to see how long they have been in business and what kind of accounting they have. Smaller companies usually have a few people doing everything. They don’t have segregation of duties or internal controls.
CPA Magazine: How big of a staff does it take?
Moss: I can do the whole audit or a staff member can with my involvement. It is not something a new, inexperienced person can work on. It may not take that much time, but there are particular reporting needs and SEC requirements even though they are not required to register [with the SEC]. You have to know the regulations that need to be addressed.
Pfluger: If it is a true startup, there may be nothing to audit because an audit is a historical review. If there are statements based on prospective financials we have procedures to review those.
Sharp: You would have a partner on the account who would budget for staff. We are peer reviewed and follow the standards for issuing financial statements.
How do they budget for the engagement?
Moss: In the smaller entity world the fee is very important. How do you juggle the work that has to be done to comply with the SEC and staff the engagement appropriately so you are not out of the range of what the small firm can tolerate? You need qualified people but you can’t run up a large budget. A lot has to do with getting to know the client, including their skill set, before you even get started. One of the things I like to do is to explain, “this is what it costs no matter what we do, and here is what it costs to do your audit.”
Pfluger: We perform analytical procedures. We still have to look at the entity and the internal control. They [smaller companies] will be thinly staffed and rarely have segregation of duties. So we have to provide them some guidance in the management letter according to SAAS 115 to help them improve on internal controls and to enhance the business based on best practices that we know from other companies. [For them] It’s kind of like seeing a trainer at a gym. The low cost provider [for an audit] will not be the best value. Suppliers, vendors, and other customers send prospective audit clients. It varies, but if there is no balance sheet, and a quarter or year-end [period to audit] with no transactions there is nothing to audit. The audit opinion cannot audit his hopes and dreams.
Sharp: When you are doing an initial audit it is hard to quote a fee unless we are able to get a good feeling on their books and records and their accounting staff. We hope to keep it in a certain range, but it is an estimate. We can’t lock ourselves in or we could always quote it at our standard hourly rates. Each situation is different.
How long does an audit take on average?
Moss: Depending on the size of the fund, and the transactions, you can complete an audit in 1-2 weeks.
Pfluger: A couple days or a week or a month depending on what is there.
Sharp: On a small company it could take 2-3 weeks including planning, field work, and wrap-up.
What problems do you encounter?
Moss: When it becomes more difficult is when the investment is not marketable, like stock in a private company. That investment is hard to value. That is where the issues come in. You determine their valuation and determine fair value from other sources.
Pfluger: There are many issues faced in the initial audit of a startup company: 1) Lack of past history – typically auditors look to past financial information to compare with the current year information to perform analytical procedures. With a startup there is no meaningful prior history to use. Often then we will try to benchmark against similar companies. 2) Lack of stability in employees performing key functions – there may be a lot of turnover in staffing the accounting area for a startup as it grows. This lack of stability can make it hard to ask questions of people as they may have not been there for the entire reporting period and many individuals may have been performing the tasks at different times. 3) Lack of focus among personnel – startups are generally a hubbub of activity with many personnel wearing many hats within the organization. They may lack the time and focus to be able to answer an auditor’s questions and respond in a timely manner. 4) Poor or weak internal controls.
Sharp: These startups don’t have much of an accounting staff, and are without decent books and records and documentation or people in place to get the information. So you spend more time obtaining the records from the client. Most of them use QuickBooks because it’s inexpensive and it gets the job done.
What software helps with the workpapers and trial balance prep?
Moss: I used CCH ProSystem fx Engagement, like many non-national firms do. I currently use CaseWare. They are all pretty similar. They each have pros and cons for workpaper management. We use Practice Aids from Thomsom Reuter’s PPC products. They have tools that address specific industries. The larger firms tailor their approach to a specific industry. The overall time is probably 10% for the financial statement and note preparation.
Pfluger: We use PPC for workpapers, and CCH ProSystem fx Engagement handles the trial balance.
Sharp: CCH Engagement and PPC.
CPA Magazine: What is the range of costs if there are no problems?
Moss: Say it is a $10,000,000 fund, $20,000 is not a bad number for an audit. It is based on who is doing the accounting at the client firm, how it is maintained. Is it a once a year thing? Some may be less, but they don’t have any issues. There are audits that are under $10,000. The number of investors increases the fee. There is additional work to determine if the investors are accredited.
Pfluger: We have to do a risk assessment and audit planning and assess internal controls. Then we go in and audit the numbers. There may not be an awful lot to do for a startup, so it can be reasonably priced. It could be as little as $5,000 to $10,000. Associated with that is what the promoter says about the company. There will be MD & A (management discussion and analysis) to review.
On a startup, you need to get a retainer and make sure you get paid. We have a milestone billing practice. We match invoices with our workflow. So on the first day of field work we send out a bill. Then we send one at the end of field work, one at drafting of financial statements, and one at the end. They have to be paying as they go along. We may take a retainer of 50% for a brand new client. Then will invoice the remaining amount, 25% at the start of field work, and then the quarterly bills.
Sharp: We obtain a retainer on anyone who is new. One of the provisions of the engagement letter includes the retainer before we begin work. This is a totally new area that has opened up for companies to raise money. Part of the engagement could be to receive a consulting fee to get them to where they want to be. This is really new to everyone, so it is hard for everyone. Part of raising money is accounting fees. It is part of raising money. But it was not available to them before.
CPA Magazine: What is the exposure for risk?
Moss: There may be a qualified financial statement, for an investment not valued according to accounting principles. I have not had an adverse or disclaimer of opinion. It could happen. If it was so material to the statements you might end up there. You find that out when you do your due diligence when you first get involved in the engagement. You go through that in the client acceptance process. You find that out in the beginning. They may have invested in something after the end of the year and it is difficult to determine fair value. Now you are facing a situation because they are already a client.
Pfluger: We talked to our E & O carrier who said this would have an added cost because of these startups. These crowdfunded companies do not fall under PCAOB [Public Company Accounting Oversight Board] so the peer review is the same. Depending on the procedures and how many startups you audit there would be additional costs [according to our professional liability insurance provider].
Sharp: The fees for professional liability can go up; so it exposes you to a greater number of people rather than to a bank. You could have a slew of people coming after you if something goes wrong. It is definitely more exposure. What will end up happening is firms that don’t do audits will look to a larger firm to do the audit.
CPA Magazine: Do you also perform valuations?
Moss: The valuation itself has to be determined by another firm, because that would be an independence issue. The firm will have to hire another valuation firm, which may be another CPA firm. There is a business valuation credential, and CPAs have it. If you are providing any assurance for an attest client a valuation would impair your independence. A separate valuation, as long as it has nothing to do with the audit could be performed-- like, for an estate planning engagement [for the same client].
Pfluger: We don’t do that kind of valuation for stocks. There are valuation credentials. It could be from the AICPA or another credential. That is not our area. We have to choose what we are going to be good at.
Sharp: It is not an area we are pursuing at this time.
Do you audit companies that you previously reviewed?
Moss: A review provides limited assurance that is limited to inquiry and analytics to evaluate whether the statements have material misstatements and correcting them. There is no confirmation, or third party verification. Some banks accept reviews. You don’t confirm anything. You make inquiries whether cash was reconciled. You ask, was accounting consistent? You perform analytics on the numbers themselves. Then you write up the statements. A review can be a $10,000 engagement.
Pfluger: A review is a different level of service. You do ratio analysis and ask questions. You get limited assurance that things are not materially misstated. With an audit you get reasonable assurance there are no misstatements. The general rule is if an audit is $1, a review is 60 cents because you don’t have to do the audit tests.
Sharp: A review is still an analytical procedure. It’s the same disclosure for both. There is not as much third party verification or confirmation. You are relying on what the company is telling you in a review. A review is certainly less. If a review is $5,000, an audit could be $10,000, $15,000 to comply with all of the procedures and documentation internally to make sure we have done everything.
CPA Magazine: What do you like to do when you’re not auditing?
Moss: Generally boating.
Pfluger: Reading and gardening, traveling and fishing. Spending time with family, my seven grown children; my youngest is 18.
Sharp: I generally like interaction with clients, helping them manage their businesses and planning taxes. I play tennis in my off-time. I play singles to stay in shape. I played doubles in the summer USTA [United States Tennis Association]. If I am losing it, it is because they are wearing me down. After 15-16 shots on one point, that is a lot for a recreational tennis player.Write comment (0 Comments)
- Written by: CPA Magazine
David Williams, Director of the IRS Return Preparer Office, presented a session at the Dallas IRS Tax Forum this summer subtitled “Rumor Control” due to the misinformation surrounding Registered Tax Return Preparers (RTRPs). Given the hostility and apparent worry many tax professionals were feeling about the registration process, Williams started the session by clarifying that it is an entry-level test.
“(It is) not a test to put people out of the business of preparing tax returns,” Williams said. “We think there are a lot of people still not registered or have or even know what a PTIN (Preparer Tax Identification Number) is.”
Williams also addressed the fact that many organizations are offering practice tests supposedly based on the official test. Williams revealed that the competency test is still being created and a passing threshold has not yet been designated but recognized vendor’s efforts to transcend the barrier of time.
“Most people have anxiety about testing. The tests available today are from vendors that are clairvoyant,” Williams joked.
The minimal competency is based on IRS publication 17. Continuing education (CE) is planned for 2012 after determining how to register the vendors offering the CE. Required, will be a yearly 10 hours of tax law, three hours of updates and two hours of ethics. The CE registration vendor will be required to inform the IRS who has taken which course according to their PTIN.
Recent statistics reveal that there are over 720,000 registered preparers. Of these preparers, 62% are not attorneys, CPAs or EAs. There may be as many as 900,000 RTRPs once mandated registration has taken effect. Of preparers, as many as 100,000 have had compliance problems and 50,000 may have been felons in the last 10 years, which could exclude them from the program.
Unable to be counted, ghost preparers are tax preparers that are not working for CPAs or have any kind of certification, registration or most importantly a PTIN. PTINs were secured in 15 minutes online, according to Williams.
The question of why to pay a fee of $64.25 when I already had a PTIN is often asked.
“Because the program is funded completely by these fees, which includes public awareness,” Williams said. “You have rights as a circular 230 responsible practitioner. The fee could come down in subsequent years. Due process rights are now available, so if your rights [to practice] are removed, you can appeal and eventually take the case to court. You have the right to be heard, to tell the rest of the story; this is also part of the fee.”
Williams illustrated the need to authenticate the preparer so it could be verified that the applicant was who they said they were. This push for authentication was accompanied by 100,000 letters that went out to applicants who did not use the actual PTIN for various reasons. The PTIN will be an annual application that is not pro-rated if applied for in the middle of the year.
The enormity of registering the nation’s tax practitioners has dictated how the matter would be undertaken. Williams described the IRS’s systematic approach to this daunting task.
“We don’t have the resources to start a massive enforcement campaign, “Williams added. “We are focusing on 1040 preparers. There are several opportunities for improvement.
Attorneys, CPAs and EAs only need to obtain a PTIN each year because they already have professional qualifications.
“In the administrative procedures act you cannot place more barriers before them to practice because they are already prepared,” Williams explained. “Fingerprinting is needed for all others. We had a long dialog with CPAs and determined that a supervised preparer does not need to be registered. You must work for a firm that is owned by an Attorney, CPA, or EA. You must be supervised by an Attorney, CPA or EA. They have high credentials and authorizations. If we determined that (it) is different in later years, we can change it. We may move to an every 3 year PTIN renewal”
Fingerprinting will be collected by two companies which tax practitioners can schedule appointments with online. One such vendor will have fingerprinting at 430 UPS offices. The fingerprinting will be sent to the FBI who will check for any felony convictions in the last ten years. The FBI will charge $17 per fingerprint but that and the testing are a one-time event. The companies will have to hire 4000 people to administer the fingerprinting services, all of which will have to be background checked to prevent the risk of identity theft.
“This is a growth industry worldwide since 9-11,” Williams stated.
Williams expects to have a referral database for preparers to refer ghost preparers in the near future. Penalties of $50 per return will be issued to ghost preparers. The Return Preparer Office will administer everything but situations regarding ethics. Circular 230 will govern ethics based on the judgment of the Office of Professional Responsibility. The determination will be made on an office-by-office basis.
“Nobody is a registered tax return preparer until after they have been tested. Then you can present yourself as an RTRP,” Williams warned. “Ghost preparers, who are not registered, can be located by questioning the taxpayers when the return appears to be assisted without a provided PTIN.”
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- Written by: Bryan C. Skarlatos
The collapse of Swiss bank secrecy, the IRS settlement with UBS, the criminal investigation of HSBC and the related IRS voluntary disclosure program all have put foreign bank accounts in the spotlight. Tens of thousands, if not hundreds of thousands, of U.S. taxpayers have foreign bank accounts. Some of those taxpayers opened their foreign bank account in order to hide money or the earnings in the account from the IRS.
However, the majority of taxpayers with foreign bank accounts never intended to hide their foreign accounts from the IRS. Some just inherited the foreign account from a relative who lived abroad at some point in their lives. Other taxpayers lived abroad themselves and opened a bank account in a foreign country as a matter of convenience or necessity. Still other U.S. taxpayers with foreign accounts never even lived in the United States but are U.S. citizens, and therefore are subject to U.S. reporting requirements, simply because one or both of their parents were U.S. citizens.
Regardless of why the foreign account was created or acquired, any U.S. person with an interest in, or signatory authority over, a foreign financial account must file a Report of Foreign Bank Accounts (FBAR) with the United States Treasury Department. The IRS recently has stepped up enforcement against taxpayers who fail to file FBARs. The basic penalty for a simple, non-willful failure to file a FBAR is $10,000 per year for 2005 and later years. (Prior to 2005, there was no penalty at all for non-willful violations.) However, if the IRS can prove that the taxpayer willfully failed to file a FBAR, or willfully filed a false FBAR, the penalties are much higher. The taxpayer can be subject to criminal prosecution and, for 2005 and later years, the IRS can impose crippling civil penalties of up to 50% of the highest balance in the foreign account for each year that the violation continues. (Prior to 2005, the penalty for a willful violation was capped at $100,000 per year.)
If the IRS catches a taxpayer who failed to file a FBAR, the IRS will either refer the case for prosecution or attempt to assert a penalty based on some percentage of the highest balance in the foreign account. In fact, even taxpayers who approach the IRS and voluntarily disclose the existence of their foreign account will be charged a penalty based on a percentage of the highest balance in the foreign account. Taxpayers who voluntarily disclosed their foreign account prior to October 15, 2009 are being charged a 20% penalty. Taxpayers who make a voluntary disclosure after October 15, 2009 are still being accepted into the voluntary disclosure program, but they will be charged a penalty of at least 20%, and probably more, of the highest balance in the foreign account.
Any penalty that is based on a percentage of the balance in the foreign account is premised on the idea that the FBAR violation was willful, and therefore, the IRS could take up to 50% of the balance in the account for each year of the violation. However, if the FBAR violation was not willful, then the penalty would be limited to $10,000 per year, and it would not be possible to charge a penalty based on a percentage of the balance in the account. Even taxpayers who have entered the voluntary disclosure program can opt out of the program and contest the willfulness penalty that is imposed as part of the program. Thus, when advising a client regarding his or her exposure to FBAR penalties, it is essential to determine whether the failure to file the FBAR was willful.
Willfulness is defined as "an intentional violation of a known legal duty." The government has the burden of proving willfulness. To prove willfulness, the government must establish that (1) the taxpayer was required to file a FBAR; (2) the taxpayer knew that he or she had to file a FBAR; and (3) the taxpayer intentionally failed to file, or falsely filed, the FBAR. It is very difficult for the government to prove that a taxpayer knew that he or she had to file a FBAR. This is particularly so, given the complete lack of FBAR enforcement over the past 30 years. Very few taxpayers and tax return preparers had ever heard of a FBAR until recently. Indeed, most IRS agents themselves were completely unaware of the FBAR filing requirements until a few years ago when FBARs began to receive more attention from the IRS.
So, how does the IRS go about proving that a taxpayer knew that he or she had to file a FBAR? The Internal Revenue Manual identifies several types of evidence that could support an inference that a taxpayer knew of the requirement to file a FBAR yet nevertheless failed to file it. Such evidence includes, but is not limited to, (1) failure to report income from the foreign bank account on the taxpayer's tax return; (2) failure to check the box on Schedule B asking whether the taxpayer has a foreign account, or falsely checking the box "No"; (3) discussions between the taxpayer and an accountant regarding the foreign bank account; and (4) false statements to an IRS agent who inquires about the existence of a foreign bank account.
Many IRS agents believe any taxpayer who failed to report income from a foreign account and failed to disclose the account in response to the question on Schedule B is a tax cheat and liar who must have known about the FBAR filing requirements yet intentionally failed to comply. Nothing could be further from the truth.
As described above, many taxpayers created or inherited a foreign account for completely legitimate, non-tax-related reasons and believed that income earned in a foreign country is not reportable in the United States until it's brought into the country. The tax code is so complicated and riddled with exceptions regarding the reporting of off-shore earnings that such a belief is very understandable. Further, Form 1040 is sufficiently complex that many taxpayers simply signed their tax returns without reviewing every line, including the line at the bottom of Schedule B asking whether the taxpayer had a foreign bank account. Most accountants never discussed this aspect of the return with their clients and simply checked the box "no," or left it blank, with no further inquiry.
Tax professionals with clients who are being threatened with crippling FBAR penalties should carefully evaluate whether the IRS can prove that the FBAR violation was willful. A taxpayer should consider contesting imposition of any FBAR penalty that is based on a percentage of the foreign account if he or she has a good explanation for why the foreign account was created, why the income earned in the account was not properly reported, and why the box on schedule B was not checked "yes." Also, it is important to establish that nothing was done to hide the existence of the account from the return preparer or the IRS. These factors, combined with sympathetic background facts regarding the taxpayer's age, health, family background and level of sophistication must be developed and forcefully presented to the IRS. In the end, taxpayers who truly did not know of the FBAR filing requirements should not be forced to pay crippling penalties for the failure to file a FBAR.
Bryan C. Skarlatos is a partner at Kostelanetz & Fink, LLP in New York, NY.
- Written by: Marvin J. Williams
The Federal Esate Tax was eliminated by "The Economic Growth and Tax Relief Reconciliation Act of 2001" passed by Congress. The elimination of the Federal Estate Tax was accomplished by a phase-out of the Federal Estate Tax over a period of several years. Under the 2001 legislation, the Federal Estate Tax was completely eliminated by the year ending December 31, 2009. This was achieved by gradually lowering the tax rates and raising the Exemption Equivalent (the amount of the estate that is not subject to taxation) between the years of 2002 through 2009.
Thus, for the year of 2010, the Federal Estate Tax has been completely repealed. However, due to the Sunset Provision of the United States Senate, the Federal Estate Tax is to be revived beginning January 1, 2011 and beyond.
All efforts to revive the Federal Estate Tax for the year of 2010 simply did not get done to the amazement and astonishment of many. Most observers expected Congress to act in some way to prevent the full repeal of the Federal Estate Tax for the year of 2010 to simply allow it to return on January 1, 2011 with vengeance.
Under the current law, the Federal Estate Tax will return on January 1, 2011 at the 2002 Exemption Equivalent Amount of $1,000,000 per taxpayer ($2,000,000 for couples) and the 2001 maximum tax rate of 55%. To go from the 2009 Exemption Equivalent Amount of $3,500,000 per taxpayer ($7,000,000 for couples) and a maximum tax rate of 45% to the much lower Exemption Equivalent Amount and higher 55% maximum tax rate scheduled for 2011 will be dramatic for many taxpayers.
Options to Address the Expiration
There were and still are options available to address the expiration of the Federal Estate Tax for the year of 2010. Any of these options will require retroactive tax legislation making such legislation effective retroactively to January 1, 2010. Retroactive legislation in the area of federal taxation is very uncommon but has occurred on occasion (the last time being the Jobs And Growth Tax Relief Reconciliation Tax Act Of 2003 which was passed on May 23, 2003 and signed into law by the President of The United States on May 28, 2003 and made retroactive for the entire year of 2003).
Excluding often unpopular retroactive tax legislation, Congress’ inability to address the expiration of the Federal Estate Tax for the year of 2010 with more moderate tax legislation will cause estates to be subject to higher tax rates and a lower Unified Transfer Tax Credit (Exemption Equivalent Amounts) for the year of 2011 and beyond.
Tax Planning Opportunities
In order for tax professionals and taxpayers to properly engage in tax planning, the status of tax legislation must be known (or be fairly predictable). Retroactively changing the current status of the Federal Estate Tax greatly hampers this opportunity.
Moreover, tax planning generally involves making certain investments, purchases, sales or other transactions or actions based on projected tax consequences of such transactions or actions. In the event that legislative action is not taken and enacted to change the current status of the Federal Estate Tax for the year of 2010, the tax consequences for decedents dying during the year of 2010 are quite different from decedents with the same Taxable Estates dying during the years of 2009 or 2011.
To highlight these differences, the chart below illustrates various tax consequences for the estate of decedents dying during the year of 2009 and contrasts those results for a decedent with the same Taxable Estate who deceased in the year of 2010 and the year of 2011.
The Federal Estate Liability computed under the various scenarios demonstrates the dramatic changes in the federal taxation of estates for the years of 2009, 2010 and 2011 under the current Federal Estate Tax provisions. As shown in Example 4 and Example 6, the Federal Estate Tax Liability more than doubled in the year of 2011 as compared to the year of 2009 on the same Taxable Estate.
Impact on Heirs
Another significant consequence of the expiration of the Federal Estate Tax for the year of 2010 is the change in the law for the basis of the person who inherits property from a decedent who died during the year of 2010. For the year of 2010 only, such basis to the heir will not be the long standing fair market value on the date of death of the decedent (step-up basis when fair market value on the date of death is more than the adjusted basis) but rather will be the carryover basis rule that applies to gifts of property.
Thus, if the property is appreciated property where the fair market value on the date of death is more than the adjusted basis to the decedent, the heir inherits property that is likely to result in income tax gain to the heir if such property is subsequently disposed of by the heir in a taxable event. The carryover basis rule basically means that the basis of the inherited property will be the same to the heir as it was to the decedent (or fair market value on the date of death if it is lower than the basis to the decedent on the date of death).
However, some adjustment is allowed for the heir (as allocated by the executor of the estate). The heir can choose to take a step-up basis in the inherited property for a maximum amount of $1,300,000 ($60,000 for decedent nonresidents who are not citizens of the United States). For any amount inherited in excess of $1,300,000, the heir’s basis in such property will be the smaller of the decedent’s adjusted basis or the fair market value on the date of death. The step-up basis adjustment for property inherited by the surviving spouse of the decedent is $3,000,000. All of these amounts are to be adjusted for inflation.
Thus, for the illustrations highlighted in the chart on page 12, the heirs of the property of the decedents dying in the year of 2010 will receive carryover basis on the inherited property (with the limited step-up basis adjustment provisions described above.) Under the current law, the long standing step-up basis adjustment returns for property inherited from decedent dying after December 31, 2010.
The Federal Estate Tax has gone through significant changes in recent years. The efforts to completely eliminate it have not been successful but a one-year hiatus of the Federal Estate Tax has been achieved. Tax planners, to the extent possible, can utilize the benefits of the no Federal Estate Tax for estates of taxpayers that decease in the year of 2010. However, the high tax rates of pre-2002 and low Exemption Equivalent amount of 2002 return in 2011 causing estates to be subject to a higher Federal Estate Tax that has not applied for several years.
This change in the amount of Federal Estate Tax for the year of 2011 suggests an imbalance and inconsistency in the application of the Federal Estate Tax. This shift in the Federal Estate Tax beckons Congress to implement a more fair, consistent and stable Transfer Tax System. Hopefully, Congress carefully and fairly addresses this dilemma soon and provides a more permanent solution in this area of Federal Taxation.
Marvin J. Williams, MBA, JD, CPA, CMA, CFM, is a professor of Accounting and Taxation at the University of Houston-Downtown.Write comment (0 Comments)