Elder Law Firm of Marshall & Associates

Unfortunately, the Act should be called the Federal Estate Tax Uncertainty Act of 2001. Because Congress was limited to $1.35 trillion in total tax cuts, the changes are phased in over a lengthy period of time. And the entire Act and all of the changes expire on December 31, 2010 due to a sunset provision.

Of immediate significance to many individuals and married couples is the gradual increase in the estate tax exclusion amounts. Currently (in 2001) the unified credit is $675,000. Under the Act, the credit (now referred to as the "Exemption") will be pegged at $1 million in 2002 and then will gradually increase to $1.5 million in 2004, to $2 million in 2006 and to $3.5 million in 2009. The generation skipping tax exemption will track this increase in the Exemption.

In addition, the Act reduces the maximum federal estate tax bracket to 50% in 2002 and eventually to 45% in 2007.

Here is a chart that shows these changes in the exemption and tax rates as established by EGTRRA of 2001.

EGTRRA of 2001 also changes the rules on the Gift Tax Exclusion. In 2001 the exclusion is $675,000, the same as the Federal Estate Tax exclusion. The Gift Tax Exclusion also rises to $1 million in 2002. However, as of January 1, 2004, the exemption is no longer unified. The gift tax exclusion does not increase after 2002. It stays at $1 million, while the estate tax exclusion continues to rise after 2004.

In 2010 the Estate and Generation Skipping Transfer Taxes are repealed in their entirety, but for that calendar year only. They return in 2011. The gift tax exemption stays at $1 million with the gift tax rate equal to the highest income tax rate at the time.

The good news for taxpayers is that the Tax Act does eventually repeal estate and generation skipping taxes; the bad news is that the repeal only lasts for one year - 2010. To stay within the budgetary restrictions, the law provides that the prior law's estate tax rules, rates and exemptions come back into force in 2011, unless Congress takes further action. This provision has been the source of much humor and derision.

The net effect is that we really don't know what the estate tax laws will look like in 2011. It's hard to predict what actions future Congress' might take. [It is estimated that in 2009 before repeal, the cost of the increase in the exemption to 3.5 million and the reduction in the top tax rate to 45% will cost the government only $12.7 billion dollars. But the cost of total repeal in the calendar year 2011 would be $53.4 billion. Congress may decide that it has other more politically palatable for that $41 billion dollar annual difference.] We have two presidential and 4 Congressional elections between now and then, so anything could happen. What we have to plan for then is not estate tax repeal - but estate tax uncertainty.

Carry over Basis in 2011

The Tax Relief Act is the "Tax Heartburn Act" at least in one respect. The Act creates a new tax on appreciated assets. Under current law, when you die, your assets receive a ''step-up in basis,'' which means stocks, real estate and other inherited assets are given a tax basis equal to their fair market value on the day of your death, not the price you originally paid. This limits the capital gains taxes that will be paid by your estate or your heirs when they sell the inherited asset.

That will change in 2010 when the estate tax is repealed. The new law will continue to allow a step-up in basis for up to $1.3 million in assets inherited by non-spouses and an additional $ 3 million inherited by a spouse. But it will create a paperwork nightmare for people who inherit a large amount of appreciated assets because they'll need to locate records documenting the original purchase price of their inherited assets. It will also create a nightmare for executors who are given the task of deciding which assets will receive a step up in basis and which will not.

My guess is that this provision in the Act will not survive until 2010. A similar but less complicated carry-over basis rule was enacted as part of the TRA of 1976 but was repealed before it was to take effect in 1980. I can only hope a similar fate awaits this section of the 2001 Act. But who knows.

Some Planning Considerations:

1. It is a mistake to think that the estate tax has been repealed and that you don't need to do any further planning. Unfortunately this is not the case. The new law doesn't make planning unnecessary, it just makes it even more complicated. Individuals who are potentially liable for estate tax (and this includes everyone who may have an over $1 million dollar taxable estate in 2011) will need to review their situation every few years.

2. Some estate tax planning techniques, like GRATs and QPRTS, and Charitable Lead Trusts, become much less attractive under the Act. Lifetime charitable gifts, with their income tax deductions still seem to make sense as do Charitable Remainder Trusts. Family Limited Partnerships and LLCs still make sense as family business management devices. And discounts may help the donor stay within the $1 million gift tax exclusion. On the other hand, I would be hard pressed to recommend making taxable gifts in excess of the $1 million dollar exclusion. Why should you incur a gift tax at all if the estate tax may be repealed.

3. Above all, in this era of uncertainty, we have to build maximum flexibility into planning for clients who may or may not be subject to federal estate tax. For this reason planning for the use of disclaimers and similar flexible planning techniques have become of critical importance to effective estate planning.

4. Couples who are have created standard mandatory funded bypass trusts in the past need to update their plans. If they don't modify their documents, the surviving spouses may end up with useless and burdensome trusts they don't need.

5. If you don't keep good records of the tax cost of your assets, you might want to start now. If the carry over basis provisions of the law do take effect in 2011, your heirs may have to figure out what you paid for your IBM stock in 1989.

The new Tax Act makes many additional changes to tax laws other than the federal estate tax. Here is a brief summary of some of the more important changes.

INDIVIDUAL INCOME TAX RATES

Of course, all of the above is subject to the now famous phrase, SUNSET. Here's the actual wording in the Act:

"IN GENERAL.-All provisions of, and amendments made by, this Act shall not
apply- (1) to taxable, plan, or limitation years beginning after December 31,
2010, or (2) in the case of title V, to estates of decedents dying, gifts made,
or generation skipping transfers, after December 31, 2010.

APPLICATION OF CERTAIN LAWS.-The Internal Revenue Code of 1986 and the Employee Retirement Income Security Act of 1974 shall be applied and administered to
years, estates, gifts, and transfers described in subsection (a) as if the provisions and amendments described in subsection (a) had never been enacted."