Estate Planning Basics II What does the new estate tax Repeal Enacted in May 2001 really Mean? What makes up my taxable estate? What are some tools that I might use to diminish federal estate taxes? Go to Estate Planning Basics I Estate Planning Basics III Estate Planning Basics IV

1. Question: What does the new estate tax Repeal Enacted in May 2001 really Mean?

President Bush has recently signed into law a major tax bill, The Economic Growth and Tax Relief Reconciliation Act of 2001." Now is the time when your clients will be looking to you for useful information and guidance.

With the new law, we are going to see cuts in individual income tax rates, and a liberalization or "simplification" of a variety of pension and employee benefit rules. But it is the new gift and estate tax rules where the Act gets a little crazy. Below are the main features of the new law. It goes to prove that your clients still need to implement estate planning techniques, for both tax and non-tax reasons.

Think of the new estate tax as a set of rules changing in three phases. In Phase One, the top estate and gift tax rate drops from 55% to 50% in 2002, and then slides down to 45% by 2009. Most of your clients will appreciate that even after reaching 45%, we still have an estate tax. It hardly matters whether the rate is 55% or 45%. That's very modest tax relief for your high net worth clients. In 2002, the unified exemption amount (per person) increases from $675,000 to $1,000,000 ($2 million for couples) - and becomes a deduction rather than a credit, meaning that many taxable estates will be subject to lower tax brackets. The exemption grows to $2 million for 2006, 2007 and 2008, and finally to $3.5 million ($7 million for couples) in 2009.

Then, Phase Two kicks in. On January 1, 2010, estate tax "repeal"occurs - nine years from now. That "repeal" is effective for one and only one calendar year; 2010 will be the only year when decedent's properties can pass to their heirs with zero estate tax. There is no exemption amount for those who die in 2010, since the estate tax will be zero for that year. The Tax Act really complicates the basis step-up rule. For those who die during 2010, estates will pass capital assets to heirs under a new "modified" version of basis carryover. The basis step-up at death rule is being "repealed," but only for the calendar year 2010.

Here's how that rule works. For someone dying in 2010, his estate will not be subject to any federal estate taxes, but the basis of all of the decedent's appreciated assets are going to have to be carried over to the survivors. At the same time, the new law will allow the estate to increase the basis of a decedent's appreciated capital assets by up to $1.3 million, plus an additional $3 million of basis adjustment for appreciated assets that pass to a surviving spouse.

In the meantime, the current basis step-up at death rule continues to be applicable for those who die before 2010, or after 2010. Think of the enormity of the task of maintaining adequate accounting records for measuring the date-of-death built in capital gains of persons dying during 2010, but that might be totally unnecessary if the same individual happens to die before or after the single repeal year 2010.

Finally, in Phase Three, a most amazing thing happens. The "repeal" of estate taxes is itself repealed - on January 1, 2011. The $3.5 million exemption is repealed, and returns in 2011 to $1 million, and the zero tax rate is repealed and returns to 55% for 2011 and after. In effect, the estate tax "sunsets" for only one year, and returns back as strong as ever, with the weird "sunrise" provision embedded in the Act. Talk about strange tax legislation!

Let's look at an example. Joe Client dies in 2010, and leaves $6 million in capital assets to his wife Jane. With an aggregate basis of $2 million, the $4 million capital gain is erased, because Joe has a total of $4.3 in basis adjustments. If Jane predeceased Joe, and these assets are passed to his children, only $1.3 million of the gain is adjusted, so there will be capital gains tax on the adjusted difference ($2.7 million).

If Joe dies in 2009 or earlier, or in 2011 or later, all of his appreciated assets will be entitled to a full basis step-up at death and the current step-rules will apply. But Joe's estate would be subject to estate taxation. If he dies after 2010, the 55% rate would apply with a $1 million exemption amount. If he dies in 2009, a 45% rate would apply, with a $3.5 million exemption. With further growth in his estate values, he could get hit with substantial estate taxes. So might his wife. And, if Congress changes the rules, between now and the date of his death, the impact may be even harsher.

No one knows when Congress will freeze the rates, stretch out the phase-down schedule, freeze or modify the exemptions, or vote to make total repeal a permanent law. In fact, we have a decade of uncertainty. This is a tax law that pretends to be tax relief, but in actuality can give U.S. taxpayers only temporary and limited relief from estate taxes.

Plus, no one has any idea whether and to what extent the various states will rush into the vacuum and increase state death taxes, grabbing funds not sought by the Federal Government.

Until the Treasury issues regulations, it's hard to know exactly how to advise your clients on spreading the basis adjustments ($1.3 and $3.0 million) among all of the assets, and to which heirs. Family estate planning does not necessarily mean that the basis adjustments should be allocated evenly or proportionately among all assets. There are situations where the parents wish to equalize an estate in special circumstances, for example, where the surviving children are not all actively involved in a family enterprise.

No rational and prudent client can ignore the need for wealth transfer tax planning during the next decade, and for the indefinite future beyond that. Only clients who wish to believe they can time their own deaths exactly during calendar year 210 can ignore estate tax planning.

2. What makes up my taxable estate?

Some important although complex issues are as follows and it is advised that you speak to your estate planning team to clarify each factor as it relates to your particular situation.

Transfers between spouses generally qualify for the unlimited marital deduction and are free of current tax. IRC Sec. 2056

The estate tax return (Form 706) and any taxes due are generally payable nine months after date of death. In some situations, a portion of the taxes may be paid to the IRS in installments. IRC Sections 6161 and 6166. If the value of the estate assets declines during the first six months after death (which often happens if the decedent owned a business), the value (for all assets) as of six months after death may be used on the tax return.

Lifetime gifts which exceed the annual exclusion ($10,000 per donee per year) will also reduce the estate owner’s unified credit.

Some transfers made during one’s lifetime may be brought back into the decedent’s estate. A few examples would include:

A. Transfer of life insurance policies within three years prior to death. IRC Sec. 2035

B. Transfer of an asset from which the donor retains an income for his of her life. IRC Sec. 2036

C. Transfer of an asset where donor retains the right to alter or terminate the transfer. IRC Sec. 2038

D. Assets placed in joint tenancy with another are included in the gross estate.

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