The Economic Growth And Tax Relief Reconciliation Act Of 2001

Article written by Donald A. Hamburg and Steven G. Chill

On June 7, 2001, President Bush signed into law the new Economic Growth and Tax Relief Reconciliation Act of 2001. By now, many of you have read newspaper and other summaries of the law which highlight the "repeal" of a variety of so-called "death taxes". Unfortunately, many of these reports are misleading, and indeed, under many typical estate plans now in place, the new law may result in unanticipated or unintended results. This Bulletin is intended to inform you about a number of areas the new legislation has NOT dealt with; as well as to alert you to the need to review your current estate plan in light of the changes made by this legislation. The new law does not give us cause for rejoicing; estate and gift taxation are very much with us and are likely to continue for some time.

Here are a few important facts relating to estate, gift and generation-skipping taxation that you will NOT find in the new tax law:

The new tax law does NOT repeal the estate tax, unless you die during the 12 month "window of opportunity" from January 1, 2010 to December 31, 2010. There is a gradual reduction in rates from the 55% top bracket under the old law to a 45% top bracket under the new law, phased in by the year 2009. There is also an increase in the estate tax exemption from the present $675,000 to $1 million in 2002, gradually increasing thereafter to $3.5 million by 2009. The tax relief that is afforded to you by the new legislation will have a short duration. Starting January 1, 2011, the same estate tax in effect before this new law was enacted will be restored under what is known as the "sunset" provision.

The new tax law does NOT repeal the gift tax, which continues under the new law. The exemption increases from the present $675,000 to $1 million in 2002 and the top bracket gradually declines from 55% to 35%. The new law does not increase the gift tax exemption over time, as is the case with the exemption from estate tax. Also, unlike the estate tax, there will be no "window of opportunity" with respect to gifts during the year 2010.

The new tax law does NOT repeal the generation-skipping tax until the year 2010, and it is resurrected in the year 2011 under the sunset provision. The new law does not increase the amount of the exemption from this tax beyond $1,060,000 (indexed for inflation) for transfers made during the years 2001 to 2003. However, for transfers beginning in 2004, this exemption increases over time to $3.5 million in the same manner as the estate tax exemption.

The new tax law does NOT provide a meaningful increase in the exemption from estate tax for those individuals whose estates exceed $3.5 million (or $7 million for a married couple).

The new tax law does NOT eliminate the capital gains tax on appreciated assets sold by your heirs by giving them a "stepped-up basis". Starting in the year 2010 (unless the old "carryover basis rules" are extended by further legislation), your heirs must use the lesser of your basis or the fair market value at the time of your death in determining the capital gains tax on assets sold following your death. An exception applies to the first $1.3 million of assets passing to any person and to $3 million of assets passing to your surviving spouse. The new law does not eliminate the requirement that you keep records of the cost basis of your assets forever, and necessitates that you research your old records to determine or to reconstruct the basis of each and every one of your assets. In an era of paperwork reduction, the new law takes a giant step backwards. Essentially, the new law does not encourage your heirs to sell appreciated assets after your death and to diversify their inherited portfolio.

The new tax law does NOT continue to let the state in which you live share a portion of your estate tax. The new law repeals the state death tax credit during the years 2002 -2004. This credit historically allowed the states to receive some of your federal estate tax dollars. This means that starting in 2005, the IRS gets all of your estate tax dollars and the states get none, leading to the possibility that the states may be forced to enact their own estate taxes to replace the lost revenue.

The new tax law does NOT benefit family owned companies. The new law repeals the special tax benefits presently given to certain "family-owned businesses".

The new tax law does NOT allow you to give your IRA, income tax-free, to charity during your lifetime. Although the Senate proposed this in its version of the law, it was not enacted.

The new tax law has several unexpected estate planning consequences, and future legislation may well change the estate tax landscape yet again. Since there are Congressional elections every two years and Presidential elections every four years, there is a good possibility that during the next decade, as the new law is phased in, four Congresses and two Presidents will have an opportunity to enact new tax legislation. We cannot predict what political and budgetary considerations may impact future legislation, but we do feel certain that estate and gift taxation (as well as related income tax and generation-skipping tax concerns) will be with us for some time. Given this uncertain climate, we suggest that a conservative approach calls for a careful review of wills, trusts and other estate planning techniques to maximize the benefits conferred by the new law and not to assume that the estate tax will "go away".

In addition to pure tax considerations, there is a need to be aware of the impact of the federal tax laws on wills and trusts. For example, many wills drafted under prior law contained a formula-based "credit shelter" bequest to children of $675,000 (increasing to $1 million in the year 2006 under the old law) with the balance of the estate going to the surviving spouse, either outright or in a marital trust. This typical disposition was driven by a desire to maximize estate tax savings and provide generously for the surviving spouse. While such an approach seemed logical under the old rules, the same may no longer be true when the estate tax exemption reaches its higher levels by 2009. For example, consider an estate of $4 million with such a formula-based "credit shelter" arrangement under a typical will, where death occurs in the year 2009. Under the new tax law, the "credit shelter" bequest for the children would be $3.5 million, leaving only $500,000 for the surviving spouse (a result wholly unintended when the will was prepared).

Clearly, wills should be reviewed and clients should continue to do active and sensible estate planning. Many of the estate planning techniques developed and tested under the old law will still serve clients well in this new and uncertain environment. Moreover, the unforseen and unintended consequences that may arise when an old will becomes operative under the new tax law should be examined and avoided.