Estate Planning
THE
NEW ESTATE TAX AND YOU
June 5, 2001
 |
By
Permission,
(c) Law Office of William J. Brisk
1150 Walnut Street
Newton Highlands, MA 02461
617/244/4373
email: briskw@neaccess.net
Two days before both houses of Congress approved
the "Economic Growth and Tax Relief Reconciliation
Act of 2001," an analyst confidently predicted
that President Bush's plan to eliminate the estate
tax would not survive the joint legislative committee.
She further opined that "it's likely the only
change made to estate planning laws will be [to]
increase the unified credit up to $2.5 million per
person."
So much for predictions about tax legislation!
On May 10, President Bush signed the tax bill for
2001 ushering in a wholesale reform of the federal
tax system which, among many other items, promises
to end the federal estate tax in the next nine years.
Although less than 2% of estates in the United States
currently pay such taxes, the changes offer both
opportunities and challenges for many of our clients.
The new law will lift the burden of estate taxes
from some clients but, like most reforms of tax
law, this one will complicate planning for many
more.
The legislated compromise is rife with inconsistencies
and ambiguities. We anticipate that, by next year,
Congress will enact "technical corrections"
to clarify the intent, soften the impact of the
new law, and fine-tune incentives. Be advised that
when Congress enacts such technical corrections
it often reconsiders key issues.
Despite its promise of eliminating estate taxes
by the year 2010, the law paradoxically imposes
a "sunset" provision which will automatically
reinstate the present estate and gift tax laws on
January 1, 2011 unless Congress re-enacts termination
of the estate tax. Opponents of many features of
the new tax law (including the estate and gift tax
provisions) believe that fiscal pressures will require
Congress to curtail or slow down the projected tax
cuts.
This Report is a first attempt to describe the likely
impact of the Tax Reform of 2001 on estate planning.
We will continue to study the law and to review
others' analyses. Therefore, readers should be mindful
of the following disclaimer:
our comments are based on a preliminary assessment
of the new tax law whose treatment of Estate, Gift,
and Capital Gains taxes is to be phased in over
the next decade. This assessment may help you to
focus on issues confronting your estate, but no
action should be taken on the basis of this Report
alone. We will be pleased to meet with clients and,
where appropriate coordinate our efforts with a
qualified CPA, to analyze the particular impact
of the law on their resources.
ELEMENTS
OF THE NEW LAW
THE EXEMPTION
The first $675,000 of estates of persons dying in
the year 2001 is exempt from estate taxes. The new
law raises the exemption in 2002 to $1,000,000,
to $1,500,000 in 2004, to $2,000,000 in 2006, and
to $3,500,000 in 2009. The estate tax would be repealed
in the year 2010 - but, as stated earlier, might
be resurrected the following year.
MARGINAL RATES
At present, taxable estates of over $3,000,000 pay
an estate tax of $1,290,800 plus a marginal rate
of 55%. The new regime will lower the marginal rate
of taxation by 5% in the first year and by an additional
1% per year from 2003 to 2007. Unless the estate
tax is revived before then, no taxes would be levied
on any estate after the year 2010.
IMPACT ON CAPITAL GAINS TAXES
The traditional estate tax sheltered from capital
gains taxes assets which had appreciated during
the decedent's lifetime. When a person died, all
of his assets at their then current fair market
value were considered part of his gross estate.
If John had purchased a home for $200,000 in 1992
and died when the home was worth $450,000, because
his estate included the house at its "date
of death" value of $450,000, his heirs received
the house at its "stepped up" value of
$450,000. Their only capital gains tax liability
arose if they sold the house for more than $450,000.
For mid-size estates (which did not pay taxes) the
"step up" was a boon. The new law will
terminate this "step up" although it is
not exactly clear when or how. The law does allow
estates to allocate up to $3,000,000 in additional
"basis" for property which the decedent
actually purchased. This feature of the new law
may actually increase net taxes for some taxpayers.
STATE DEATH TAX CREDITS
Most states, including the Commonwealth of Massachusetts,
peg their own estate taxes to the maximum allowable
credit offered by the IRS so that whatever the estate
pays in state taxes reduces, dollar-for-dollar,
what it owes to the IRS. The new law reduces the
size of the credit by 25% in 2002, 50% in 2003,
and 75% in 2004, and eliminates the death tax credit
beginning in the year 2005. States like Massachusetts
will have to decide whether to adjust their estate
taxes to the diminishing allowable credit or collect
estate taxes for which no federal credit will be
allowed. State legislatures have only seven months
to react to this significant fiscal and tax change.
GIFT TAXES
Traditionally, an individual could gift, each year,
up to $10,000 to each object of her bounty. Any
excessive gifts at first reduce the exemption ($675,000
in 2001). After the exemption is exhausted, a generous
donor pays gift taxes at the same rate as are assessed
for estate taxes. The planned phaseout of estate
taxes, surprisingly, will not treat lifetime giving
as kindly. The lifetime exemption on gifts will
rise to $1,000,000 in 2002 - and stay there for
nearly a decade.
TRANSFERS OF BUSINESSES AND FARMS
One of the arguments for eliminating the estate
tax was that it forced too many families to liquidate
family farms and businesses whose capital value
exceeded $1,000,000. Congress rejected proposals
to give special treatment to such family businesses
except that the new law expands an estate's right
to pay estate taxes on a favorable installment basis.
SUMMARY
The chart below summarizes the changes in the exemption
and highest marginal tax rates as elimination advances.
Estate and Gift Tax Rates and Unified Credit
Exemption Amount
| Calendar
year |
Estate
and GST tax
deathtime transfer exemption |
Highest
estate and
gift tax rates |
| 2002 |
$1
million |
50% |
| 2003 |
$1
million |
49% |
| 2004 |
$1.5
million |
48% |
| 2005 |
$1.5
million |
47% |
| 2006 |
$2
million |
46% |
| 2007 |
$2
million |
45% |
| 2008 |
$2
million |
45% |
| 2009 |
$3.5
million |
45% |
| 2010 |
N/A
(taxes repealed) |
Top
individual rate
under the bill
(gift tax only) |
CONCLUSION
The taxation of estates and gifts will significantly
change on January 1, 2002. While almost every tax-paying
estate will pay less under this reform, the changes
are so sweeping that most couples with more than
$2,000,000 in combined assets should reevaluate
their plans. This is particularly true for couples
and individuals:
| • |
whose
present plan includes "bypass" or similar
trusts to be funded when one spouse dies.
Such trusts allow a couple to, in effect,
double their use of the exemption by funding
a special trust for the lifetime benefit of
the surviving spouse with a sum based on the
size of the exemption in the year the first
spouse dies. In 2001, if Berta died owning
$900,000 in her name, a typical bypass trust
would take $675,000 and her husband, Bruce,
would receive $225,000 outright. According
to the new law, if Berta died in the year
2002, all $900,000 of her assets would go
into the trust restricting Bruce's right to
use the principal. Many clients may want to
consider new formulas for funding such trusts. |
| • |
whose
estates include highly appreciated assets.
Elimination of the estate tax is coupled with
the elimination of the "step up" in basis.
The result is that heirs receiving assets
which have appreciated (especially if decedent
had received them by gift or descent) may
incur significant capital gains taxes. |
| • |
depending
upon how Massachusetts and other "sponge tax"
states react to the eventual loss of the "state
tax credit," our residents may want to re-evaluate
their planning or even their domicile. |
This
unprecedented increases in the exemption and the
steady decline in estate tax rates (at the highest
marginal rate only, however) implies that the best
"planning" involves good health and good
spirits - two things we wish all of our clients. |
