United States: Death Is Still A Sure Thing, But What About The Estate Tax?

As the saying goes, the only two things you can count on in life are death and taxes. However, with the passage of the $1.35 trillion Tax Relief Act of 2001, which was signed into law by President Bush on June 7, 2001, more uncertainty than certainty has been created with regard to the gift and estate tax. For example, while the estate tax (but not the gift tax) has been repealed under the act, such repeal will not take effect until Jan. 1, 2010, and then only for that year with the estate tax scheduled to be reinstated in 2011 unless the repeal is extended. Accordingly, heirs of an estate will only reap the maximum benefits under the new tax act if an individual dies in 2010.

Between now and 2010 there are benefits under the new tax legislation that will likely prove to be very advantageous to most Americans. For instance, as of Jan. 1, 2002, the estate tax exclusion (the amount every individual can exempt from estate tax) will be increased from $675,000 to $1 million. Raising the exclusion to $1 million will eliminate the estate tax for a large percentage of estates. Internal Revenue Service statistics for estate tax returns filed in 1999 indicate about 38 percent of all taxable estates would not in fact have owed any federal estate tax if the exclusion had been $1 million.

In future years, the exclusion amount will increase as follows: in 2004, it will increase to $1.5 million; in 2006, to $2 million; and in 2009, to $3.5 million. However, if the repeal of the estate tax is not extended, in 2011, the exclusion amount will be reduced to $1,000,000, until further action by Congress.

While on the one hand Congress and the president did giveth with regard to the increase in the estate tax exclusion, on the other hand, while they did not taketh away, they did not giveth as much when it comes to taxation of gifts made during lifetime. Prior to the new tax legislation, the exclusion from taxation for both estates and gifts was the same, resulting in a "unified" system. As of Jan. 1, 2002, the exclusion for gifts will go up to $1,000,000, but is not scheduled to be increased beyond that point and will not be repealed (even for one year) under the new act.

In addition to the substantial increases in the exclusion amount for estates, the top estate/gift tax rate is scheduled to be reduced over the next nine years until the complete repeal of such tax occurs in 2010. Currently, the highest marginal estate/gift tax rate is 55 percent, with a surtax of an additional 5 percent on estates having a value of between $10,000,000 and $17,800,000. As of Jan. 1, 2002, the top marginal rate applying to estates and gifts will be reduced to 50 percent and the 5 percent surtax will be eliminated. Starting in 2003, such rate will be reduced by 1 percent each year until the top rate equals 45 percent.

One of the quid pro quos for repealing the estate tax is that the current unlimited "step-up" in income tax basis to fair market value for most property transferred at death will be limited in estates of decedents who die after 2009. Specifically, the step-up in basis will only apply to $1.3 million of the decedent’s property, with an additional $3 million available for property passing

to a surviving spouse. The basis of property received from a decedent and not subject to the step-up in basis will have a "carry-over" basis, which will be equal to the decedent’s basis in such property prior to death. Thus, upon subsequent disposition of property that has not benefited from a step-up in basis, the recipient of such property will most likely be subject to income taxation on both pre-death and post-death appreciation.

The most certain thing we can say about the new legislation as it pertains to the estate and gift tax rules is that, because of its uncertainty, planning an estate will be more challenging during the coming years. While repeal of the estate tax sounds good, most estate planners are urging their clients to focus primarily on the near-term relief, not on the possibility of complete repeal. Accordingly, it is now more important than ever to find an advisor who can provide comprehensive advice in order to navigate the complex and ever-changing rules wrought by Tax Relief Act of 2001.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.