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The Economic Growth and Tax Relief Reconciliation Act of 2001
Congress has passed, and the President has signed, The Economic Growth and Tax Relief Reconciliation Act of 2001, repealing the federal estate tax and sharply reducing the gift tax. How does the Act work? What does it mean for you? What should you do?
How the Act Works
The estate, gift and generation-skipping tax provisions of the Act have four basic components:
1. Repeal. The estate and generation-skipping transfer taxes are repealed so that they do not apply to the estates of decedents dying after December 31, 2009, or to generation-skipping transfers occurring after that date.
2. Reduction in Rates. The estate, generation-skipping transfer tax, and gift tax rates are reduced modestly in the period prior to full repeal. For persons dying after December 31, 2001, and for gifts made after that date, the top rate (applicable to estates and cumulative gifts in excess of $2,500,000) is reduced from the current 55% to 50%. In addition, the 5% surtax that applies to transfers in excess of $10,000,000, but under $17,184,000, is eliminated.
After December 31, 2002, the top rates will be as follows:
|2007, 2008 and 2009||45%|
After December 31, 2009, when the estate and generation-skipping transfer taxes are fully repealed, the top rate for gifts (which applies to cumulative gifts in excess of $500,000) will drop to 35%.
3. Increases in the Exemption Amount. The lifetime exemption from estate tax (applicable exclusion amount), currently $675,000, is increased as follows:
|2006, 2007, 2008||$2,000,000|
The GST tax exemption, currently $1,060,000, will become the same as the applicable exclusion amount listed above.
The lifetime exemption applicable to gifts will go to, and then stay at, $1,000,000 after December 31, 2001. Beginning in 2002, this will be a significant change from current law, which allows the same exemption for both gift and estate tax purposes.
4. Carryover Basis. When the estate tax disappears in 2010, the step up in income tax basis that automatically applies to assets received on death will also disappear, with two exceptions. This means that any asset you receive by inheritance will have as its income tax basis the decedent's basis (in general, what the decedent paid for the asset), rather than the fair market value of the asset on the decedent's date of death. There is, however, a general step up in basis in the amount of $1,300,000, which the executor may allocate to any assets and an additional step up of $3,000,000 which applies to assets transferred to a spouse, either outright or in trust.
What Does this Mean for You?
Unless you are sure to die in 2010 or later, this simply may mean a lower estate tax bill for your heirs, and, especially as the applicable credit amount increases, new possibilities for gifts, including gifts to grandchildren and more remote descendants. After 2009, it will mean significant tax savings, and a whole new approach to estate planning.
Several caveats are in order, however. First, actual repeal is scheduled to last only for one year. The Act contains a curious "sunset" provision, stating that the Act, and all it contains, will disappear in 2011. Unless the sunset provision is repealed or modified, the current estate tax regime, or some semblance of it, will reappear at that time.
Second, there will be four new Congresses between now and then, and at least one new President, -- and a page from history is cautionary. Prior to 1977, the top estate tax rate was 77%. Congress reduced this to 70% in the 1976 tax bill, and then further reduced it to 50% in the 1981 tax law. Because of the revenue effects, however, Congress "phased-in" the decrease, dropping the rate 5% each year until 1985, when the 50% rate would take effect. Somehow, it never got there. In 1984 Congress deferred the date that the 50% rate would take effect until 1988; then it was deferred to 1993, and then finally Congress said "never" and made 55% the top rate. At the same time Congress added a 5% surtax, raising the marginal rate to 60% for some estates. In short, a lot can happen between now and 2009.
A further caveat: The Act appears to have been drafted in great haste, and there will probably be numerous "corrections," some of which may make substantial changes, offered in the coming years.
Finally, the Act is financed, in part, by a reduction in the credit allowable for state death taxes paid, in effect transferring the cost of the Act during the transition period to the states. Our friends who live in New York should note that when New York repealed its own estate tax and enacted a "pick-up" tax to collect only the amount allowed as the federal credit for state death taxes, it defined that credit as the credit in the Internal Revenue Code in effect in 1997. Thus the Act may result in a higher New York estate tax than the available federal credit. There may be a New York tax in estates that have no federal tax and in estates that previously were "tax-free" in New York due to the use of a combination of the marital deduction and the credit shelter. Other states with "pick-up" taxes may present similar problems, and there is the possibility that many states will enact new taxes to make up for the loss in revenue.
In summary, the effects of the Act are uncertain, and they may not be entirely as some publicists declare. Nonetheless, and no matter what happens in the coming years, it is likely that your gift, estate and generation-skipping transfer tax bill will be markedly reduced.
What Should You Do?
First, it is always a good idea to review your will and estate plan (or have your attorney do it) whenever there is a change in the law, a change in your family, a change in your financial circumstances, or simply the passage of time. Having said that, no immediate changes are called for by the Act. If your will creates a credit shelter trust making use of the applicable exclusion amount, the fact that that amount is increasing will, in most cases, require no change, because those provisions are typically drafted using a formula that refers to the applicable exclusion amount by name, without using any specific number. If, however, you are concerned that the increase in the exemption will cause more to pass under this clause than you had planned, you may wish to reconsider how your will works. This would most commonly be a concern where your spouse is not a beneficiary of the credit amount.
Second, some suggestions are clear:
- Defer, defer and defer. To the extent that you can put off the payment of taxes, you should. The marital deduction allows you to defer the tax payments until the death of the survivor of you and your spouse. To the extent that you are not already using the marital deduction to the fullest extent, and can, you will want to consider it.
- Don't stop any program of tax free gifts; in fact, continue considering such a program. Annual exclusion gifts ($10,000 or $20,000) to family members, direct payments of medical expenses and tuition, tax free Grantor Retained Annuity Trusts (GRATs), tax free charitable trusts, and gifts that make use of the available applicable exclusion amount all make good sense, and if something falls apart with estate tax repeal, you will be glad you did not overlook these ideas.
Other planning is less straightforward. Should you hold off on all other gifts, in the expectation that you (or your spouse) will still be alive in 2010 and the repeal of the estate tax will itself not be repealed? Perhaps, if tax minimization or avoidance are the sole reasons you have for making gifts. Perhaps not, however, if you are not one hundred percent convinced that both the law and you will survive, or if you have other reasons for making gifts. We are looking at a day when your actual aims rather than simply avoiding taxes, may be the paramount driving force in making estate plans.
Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
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© Copyright 2001