Death of the Death Tax? Some Questions and Answers for Estate Planning Clients
June 2001
The Economic Growth and Tax Relief Reconciliation Act of 2001, signed by President Bush on June 7, 2001, appears at first glance to promise significant tax relief. In particular, many politicians and members of the media announced that this legislation repealed the "death tax." The substance of the legislation, however, does not exactly live up to its billing. This On the Subject… summarizes the important estate planning related provisions in the new legislation in a question and answer format. We expect to provide more details in future On the Subject… releases.
Did the legislation repeal the federal estate tax?
Yes and no. The legislation repeals the federal estate tax for decedents who die in the year 2010. For decedents who die before 2010, the legislation increases the exemption amount and decreases the rate of estate tax (discussed below). After 2010, however, the repeal of the estate tax (and all the other provisions of the legislation) "sunsets," which means that on January 1, 2011, the estate tax will be reinstated in its current form. Thus, the estate tax repeal is good for only one year. The legislation took this form due to budget procedure rules in Congress. Congress may extend the repeal of the estate tax in coming years, but whether it will do so is uncertain.
How did the legislation change estate tax exemptions and rates?
The legislation did not change the estate tax rates and exemption for decedents who die in 2001 but did change the maximum estate rate and exemptions for the years 2002 through 2009, as shown on the following chart:
| Year | Maxium Estate Tax Rate | Exemption |
| 2001 | 55% | $675,000 |
| 2002 | 50% | $1 million |
| 2003 | 49% | $1 million |
| 2004 | 48% | $1.5 million |
| 2005 | 47% | $1.5 million |
| 2006 | 46% | $2 million |
| 2007 | 45% | $2 million |
| 2008 | 45% | $2 million |
| 2009 | 45% | $3.5 million |
For the year 2010, the estate tax will not exist. For the year 2011 and thereafter, if Congress does not extend the repeal of the estate tax, the top estate tax rate will be 55% with a $1 million exemption (not indexed for inflation).
Will my estate still have to pay state death taxes?
Possibly. Under current law, all states impose a death tax equal to the maximum credit for state death taxes allowable under federal estate tax law (a "pick up tax"). Some states have additional estate or inheritance taxes that may exceed the credit for state death taxes. The new tax legislation reduces the state death tax credit starting in 2002 and repeals it for years after 2004. The elimination of the state death tax credit means that states with only pick up taxes may lose a considerable amount of revenue. As a result, some states may enact death taxes to compensate for the loss. If this occurs, the actual combined federal estate tax and state death taxes may exceed the percentage of an estate that goes to death taxes under the current law.
Did the legislation repeal the gift tax?
No. Although many of the legislative proposals would have repealed both the estate and gift tax, Congress decided to only repeal the federal estate tax. Congress concluded that repealing both the gift tax and the estate tax would cause too great a revenue loss, primarily due to perceived income tax avoidance opportunities that would result from a repeal of the gift tax.
Did the legislation increase the gift tax exemption and reduce gift tax rates?
Yes and no. The tax legislation increases the gift tax exemption to $1 million effective January 1, 2002. Under prior law, the gift tax exemption was scheduled to reach $1 million on January 1, 2006. The legislation reduces the maximum gift tax rates as follows:
|
Year |
Highest Gift Tax Rate |
|
2001 |
55% |
|
2002 |
50% |
|
2003 |
49% |
|
2004 |
48% |
|
2005 |
47% |
|
2006 |
46% |
|
2007 |
45% |
|
2008 |
45% |
|
2009 |
45% |
For the year 2010, when the estate tax is repealed, the top gift tax rate will be the same as the top marginal federal income tax rate. On January 1, 2011, unless Congress passes contrary legislation, the top gift tax rate will return to 55%. The exemption will continue to be $1 million.
Will my heirs have to pay capital gains tax on appreciated assets they receive on my death?
Yes and no. Until 2010, when the estate tax vanishes, your heirs will receive a new basis in property you pass to them on death equal to the fair market value of that property on your death. If you die in 2010, when there is no estate tax, your heirs will generally inherit your basis in appreciated property they receive from you, which means that if and when they sell the property, they will pay a capital gains tax if the property has appreciated since you purchased it. In 2010, the legislation does give your heirs $1.3 million of new basis on your death, and if your spouse survives you, he or she will receive an extra new basis equal to $3 million. In both cases, your executor will determine which items of property receive the new basis. Under these rules, the amount of basis allocated to an asset cannot exceed its value at your death. After 2010, when the estate tax reappears, these "carryover basis" rules will expire.
Do I need to change my estate planning documents?
Not immediately. As noted above, the estate tax will not be repealed until 2010 and only then for one year. So from a broad perspective, there is no hurry to change wills and revocable trusts. The change in exemptions, while important, does not necessarily mean you should change your estate planning documents. Our wills and revocable trusts rely on formulas, rather than specific dollar amounts, to make efficient use of our clients’ estate tax exemptions. This allows our clients to not have to change their wills and revocable trusts each time that Congress changes the amount of those exemptions. Furthermore, Congress did not make any substantive changes in the federal estate tax laws, many of which dictate how we prepare documents, such as how gifts to spouses qualify for the marital deduction and who can act as a trustee of certain trusts.
It is possible, however, that the intended effect of some estate plans may change with the large increases in exemptions. We are currently analyzing this issue.
Are there any new estate planning opportunities under the new legislation?
Yes. The most significant immediate change is the increase in the gift tax exemption from its current $675,000 to $1 million on January 1, 2002. Clients who have already started a gift program will be able to make additional gifts starting in 2002 without paying gift tax. The amount of a tax-free gift, however, must be individually determined based on the client’s prior gifts and gift taxes previously paid. Because the gift tax exemption will remain at $1 million indefinitely, clients who wish to take advantage of the increase in the gift tax exemption should make their new gifts promptly after January 1, 2002, in order to shelter as much of the total return as possible on the property transferred by gift.
Apart from the increase in exemption, however, the legislation does not fundamentally change the role of gifts in estate planning for the next several years. Accordingly, we will continue to recommend the same gift giving strategies for clients looking to make tax efficient wealth transfers during their lifetimes.
What were the significant income tax provisions of the legislation?
As with the estate tax, while politicians and the media suggested that the legislation will bring significant income tax relief, there may be less than meets the eye:
Income Tax Rates. The legislation gradually reduces the top marginal federal income tax rate from 39.6 percent to 35 percent by 2006.
Alternative Minimum Tax. The legislation increases the alternative minimum tax exemption through 2004 by $2,000 per person. One of the side effects of the reduction in the top marginal rate for high income taxpayers will be an increased incidence of the alternative minimum tax on those taxpayers, particularly those who reside in states with high state income taxes.
Section 529 Plans. One of the few changes in the tax law that takes effect on January 1, 2002 is the repeal of federal income tax on distributions from a qualified state tuition program, also known as a "529 plan," used to pay for the donee’s higher education expenses, including tuition, room and board. This change will allow you to set aside money for a child’s or grandchild’s education in a way that qualifies for the gift tax annual exclusion and that is not subject to income tax while invested or when distributed, provided the donee uses the funds for his or her higher education. Like all the other changes in the new legislation, however, this exemption from income tax will "sunset" on December 31, 2010 unless Congress extends the exemption.
For a detailed chart of estate, gift and GST tax rates and exemptions under H.R 1836 please click here^.
