The 2010 estate tax exemption was $5 million per individual with a top rate of 35%, but only after Congress retroactively reinstated the tax in mid-December of that year. For most of 2010 the federal estate tax was technically repealed, and the December law gave executors a choice: accept the reinstated tax with its $5 million exemption and stepped-up basis for heirs, or opt out entirely and use a set of modified carryover basis rules under Section 1022 of the tax code.1Internal Revenue Service. Notice 2011-66
Why 2010 Was a Repeal Year
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) put the estate tax on a decade-long glide path. The exemption rose and the top rate fell each year, reaching $3.5 million and 45% in 2009. In 2010 the tax disappeared entirely.2EveryCRSReport.com. Estate Tax Options
EGTRRA had a built-in sunset. Without new legislation, the exemption would revert to $1 million and the top rate would jump to 55% starting in 2011. Congress spent most of 2010 deadlocked, and the year came and went with no estate tax on the books.
The December 2010 Retroactive Law
On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.3Social Security Administration. President Signs H.R. 4853, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 The law brought the estate tax back for the whole calendar year, but on more generous terms than 2009, and it let executors reject the reinstated tax and stay under the original repeal rules. That dual-track structure was Congress’s way of sidestepping a constitutional fight over retroactivity while still collecting revenue.
Someone who died in February 2010 had their estate governed by a law that would not exist for another ten months. That created real planning problems for families and their advisors.
Option One: The Reinstated Estate Tax
Under the reinstated tax, the first $5 million of an estate passed federally tax-free. Only value above that threshold was taxed, at rates topping out at 35%.4Office of the Law Revision Counsel. 26 USC 2001 – Imposition and Rate of Tax That was a jump from the 2009 exemption of $3.5 million and a drop from the prior 45% top rate.
Heirs of estates that used the reinstated tax got a stepped-up basis in inherited property. Assets were treated as if the heir had acquired them at fair market value on the date of death, so gains that had built up during the deceased person’s lifetime were wiped out for income tax purposes. An heir could sell shortly after inheriting and owe little or no capital gains tax.
Executors who took this route filed Form 706, the standard federal estate tax return.
Option Two: The Section 1022 Opt-Out
Executors could instead reject the estate tax entirely, no matter how large the estate. A $50 million estate could pass without a dollar of federal estate tax. In exchange, heirs took the property under modified carryover basis rules rather than getting a step-up.1Internal Revenue Service. Notice 2011-66
Carryover basis means heirs inherit whatever the deceased person originally paid for an asset. If a parent bought stock for $20,000 decades earlier and it was worth $500,000 at death, the heir’s basis was $20,000, and selling would trigger capital gains tax on the full $480,000 of built-up appreciation.
The $1.3 Million and $3 Million Basis Increases
Congress softened carryover basis by giving executors two pools of basis increases to allocate across estate assets. A general increase of $1,300,000 could be spread across any property. An additional $3,000,000 was available for property passing to a surviving spouse, for a maximum combined adjustment of $4,300,000.5Justia Law. 26 USC 1022 – Treatment of Property Acquired From a Decedent
Executors chose which assets received the bump. The efficient move was usually to load the increase onto the most heavily appreciated assets, where the built-in gain would produce the biggest future tax bill. Doing that required detailed records of what the deceased paid for every asset. Missing purchase records could result in a basis of zero, making the entire sale proceeds taxable when the heir eventually sold.
Which Property Qualified for the Spousal Increase
The extra $3 million was limited to qualified spousal property. That meant property passing outright to the surviving spouse, plus certain trust arrangements where the spouse held a lifetime income interest (qualified terminable interest property). Property passing to children, other beneficiaries, or trusts that did not meet these tests drew only from the $1.3 million general pool.
How Executors Chose Between the Two
The math turned on estate size and how much appreciation the assets carried.
For estates at or below $5 million, the reinstated tax was almost always better. There was no estate tax to pay at that size, and heirs got a full step-up in basis. Opting out would only strip away the step-up without any offsetting benefit.
For large estates loaded with heavily appreciated property, opting out often won. Paying no estate tax at 35% above the exemption threshold could be worth more than the value of a stepped-up basis, especially if heirs planned to hold rather than sell quickly. The tradeoff was accepting future capital gains exposure when the property was eventually sold.
Filing Form 8939 and the Deadline
Executors who opted out filed IRS Form 8939, “Allocation of Increase in Basis for Property Acquired From a Decedent.” The form identified each asset, its fair market value at death, the decedent’s original cost basis, and how the executor allocated the available basis increases. It served as the binding record of the election and set the tax treatment of every inherited asset going forward.
The IRS originally set the Form 8939 deadline at November 15, 2011, then extended it to January 17, 2012. The agency said it would not grant further extensions and would accept late filings only in narrow circumstances involving conflicting executors or disaster-related postponements.1Internal Revenue Service. Notice 2011-66
If an executor missed the deadline, the IRS did not automatically default to one option. It reserved the right to determine the estate’s status based on the facts and circumstances, including estate value and the economic effect on heirs. In practice, failing to file surrendered control over the outcome.
The Election Was Irrevocable
Once filed, the choice was permanent. No mechanism existed to switch tracks later if circumstances changed or hindsight suggested the other path.1Internal Revenue Service. Notice 2011-66 For large estates, the difference between the two paths could run into millions of dollars.
What the 2010 Exemption Did Not Cover
A few adjacent taxes worked differently, and estates that focused only on the $5 million estate tax exemption sometimes missed them.
The federal gift tax was not repealed in 2010. The lifetime gift tax exemption stayed at $1,000,000, where it had been since 2002, with a top rate of 35%.6Internal Revenue Service. 2010-2016 Gifts Statistics of Income Bulletin Someone could leave an unlimited estate at death with no federal estate tax while giving away more than $1 million during life triggered gift tax at 35%.
The generation-skipping transfer (GST) tax was technically reinstated for 2010 but set at a zero rate for all transfers made during the year. The tax existed on paper; nothing was owed. Families who funded trusts for grandchildren during that window paid no GST tax on the funding itself, though later distributions could still face GST tax once rates returned if no exemption had been allocated to the trust.
State estate and inheritance taxes ran on their own tracks. Several states kept their own estate taxes with exemption levels well below $5 million, and those liabilities applied through 2010 regardless of what happened federally.