ESTATE TAX IS REPEALED – MAYBE

(Time to Review Your Estate Plan)

By Michael S. Kutzin, Goldfarb Abrandt Salzman & Kutzin LLP

On June 7^th, 2001, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001. Among the many changes to the tax laws is the so-called Estate Tax repeal.

....Unless Congress acts between now and 2011, the tax law completely reverts in 2011 to what it was prior to the enactment of the Estate Tax repeal.

At first glance, the provisions of the Estate Tax repeal look generous: increased exemption amounts, reduced tax rates over time, and a complete repeal of the estate tax in 2010. However, as will be explained below, the repeal is only effective if a person dies in 2010 – the changes in the law embodied disappear in 2011. In other words, unless Congress acts between now and 2011, the tax law completely reverts in 2011 to what it was prior to the enactment of the Estate Tax repeal. The Federal Estate Tax reappears with a $1 million unified credit (as it was scheduled to increase by 2006 to prior to the 2001 law) and the tax rate reductions disappear.

Notwithstanding the “resurrection” clause in the new law, the changes to the law are significant, and every estate plan should be reviewed in light of these changes, which are discussed in greater detail below:

Increased Exemption Amounts....
This change alone makes a review of an existing estate plan essential.

Increased Exemption Amounts. Prior to enactment of the new law, the first $675,000 of a taxable estate and taxable lifetime transfers escaped Federal Estate Tax, and that amount was scheduled to increase to $1 million in 2006.

Under the new law, the exemption amounts will be as follows:

This change alone makes a review of an existing estate plan essential. For example, for clients who have will providing for a “credit shelter trust” to maximize tax savings, the result may be the unnecessary “trusting up” of assets where the estate may be small enough to escape taxation even if all assets are left to a surviving spouse. (Larger estates will require review for other reasons, to be discussed below.)

However, any revisions to estate plans must also take into account the fact that the Federal Estate Tax regime as it existed before the new law was signed comes back into effect in 2011, absent Congressional intervention.

Reduction in Rates. Beginning in 2002, the top Estate and Gift tax rate drops to 50%, and the additional 5% surcharge applied to large estates to “recover” the unified credit is eliminated. In addition, the highest Federal Estate Tax rate is reduced to the following rates:

Elimination of Stepped-Up Basis at Death. In 2010, as the Federal Estate Tax is scheduled to disappear, so will the unlimited “step up” in basis.

People with substantial estates, or who own substantial assets with a low basis, must consider revising their wills to maximize use of the step-up and to determine which beneficiaries should inherit stepped-up assets.

For computation of capital gains tax on the sale of an asset, under current law, the tax basis of the asset of someone who dies is generally “stepped up” to fair market value at the date of death. Thus, if an asset is sold shortly after the death, the capital gain that must be recognized is either reduced or fully eliminated.

Commencing in 2010, however, an executor can only elect to increase basis, on an asset-by-asset basis, by up to $1.3 million. In addition, an executor may also elect to increase basis by up to $3 million of assets transferred, either outright or in a QTIP trust, to a surviving spouse.

People with substantial estates, or who own substantial assets with a low basis, must consider revising their wills to maximize use of the step-up and to determine which beneficiaries should inherit stepped-up assets.

No Repeal of Gift Tax – Exemption Increased and Rates Decreased. Unlike the Federal Estate Tax, the Federal Gift Tax is not scheduled to disappear in 2010. In fact, the exemption amount will only increase to $1 million, effective 2002. The tax rates, however, are scheduled to decline in the same manner as will the Federal Estate Tax rates – and after 2009, the maximum Federal Gift Tax rate will be 35%.

While the new law limits the amount that can be transferred during lifetime without incurring a transfer tax, the combination of gifts within the $1 million limitation, increased exemption amounts (and ultimate Federal Estate Tax repeal) and basis step-up provides opportunities to reduce or eliminate taxes that should be reviewed with an estate planning attorney.

All existing estate plans ... should be reviewed and revised to provide for maximum flexibility and benefit under any of the potential future scenarios.

Estate Tax Redux. As discussed earlier, every provision of The Economic Growth and Tax Relief Reconciliation Act of 2001, including the Estate Tax repeal, will become a nullity in 2011 unless Congress revises the law between now and 2011. The strong likelihood is that many provisions of the law will be changed before 2011. Whether the Federal Estate Tax will be resurrected in 2011, and if so, in what form, will depend upon which political party is in power, the state of the economy, and other factors that cannot be determined at this time.

All existing estate plans, however, should be reviewed and revised to provide for maximum flexibility and benefit under any of the potential future scenarios.

Estate Plan Review.Contact Michael S. Kutzin, Goldfarb Abrandt Salzman & Kutzin LLP, to find out about a review of your existing estate plan, or, if you have none, to devise an appropriate plan in light of these changes to the tax law.