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Estate Planning under the EGTRRA of 2001

Estate planning will be affected by the 2001 Tax Act in various ways. This new law gradually eliminates the estate tax by increasing the amount that is exempt from the tax over several years, reducing the top rate over several years, and finally repealing the estate tax for individuals dying after 2009. But there is a quirk in the law. To comply with budgetary rules, the 2001 Act contains a so_called sunset rule under which the pre_2001 Act rules return after 2010 unless Congress provides otherwise at some future time. This means that the estate tax is repealed only for those who die in 2010. The changes are quite complicated and will require most estate plans to be reevaluated.

Under pre_2001 Act law, there is no gift tax and no estate tax on the first $675,000 of combined transfers during life or at death, for gifts made and individuals dying in 2001. These two taxes are tied together under a unified system having a top rate of 55%. However, there are differences between the gift tax and the estate tax. One difference potentially affects the income tax of donees (recipients) of gifts and heirs of estates. A donee generally gets the donor's basis (usually cost) for a gift. As a result, if there is a gift of appreciated stock, for example, the donee will have a taxable gain if he sells at the gift value. Property acquired from a decedent, however, generally gets a basis equal to its value at his death. This means that, on a later sale by the heir, he won't have to pay income tax on the appreciation in the property that occurred while it was held by the decedent.

The new law substantially increases the $675,000 exemption after 2001. It rises to $1 million for 2002 and 2003, $1.5 million for 2004 and 2005, $2 million for 2006 through 2008, and $3.5 million in 2009. There is also a change to the unified system. The gift tax exemption amount remains at $1 million for all years after 2001, and the gift tax is not being repealed during 2010 as the estate tax is. Only the estate tax exemption amount will rise to more than $1 million. Under the sunset rule, the exemption will go down to $1 million for both estate and gift tax purposes in 2011.

The top estate and gift tax rate drops to 50% in 2002, 49% in 2003, 48% in 2004, 47% in 2005, 46% in 2006, and 45% in 2007 through 2009. In 2010, there will be no estate tax and the top gift tax rate will be 35%. The top estate and gift tax rate reverts to 55% in 2011.

Individuals should continue to write wills and develop estate plans to ensure that their assets will pass as they desire and that special needs of particular heirs will be properly addressed. This is so even if there is a good chance of survival until a year when estate tax won't be owed because of the increasing exemption or repeal. Individuals who may have an estate larger than the increasing exemption amount (or the $1 million amount that will apply for 2011 after estate tax is restored one year after it is repealed) should consider making annual exclusion gifts each year. The gift tax annual exclusion allows you to give $10,000 to an unlimited number of donees each year without paying gift tax. By doing this, the gift amounts are removed from your estate resulting in estate tax savings. In addition, the post_transfer growth in the gifts are removed from your estate. Other steps to reduce estate tax might include setting up a life insurance trust, establishing a grantor retained annuity trust, and placing one's residence in a special type of trust.

Married couples should shift assets between them so that each spouse has sufficient assets to take advantage of the increasing exemption. Also, their wills should establish a so_called bypass or credit_shelter trust. Such a trust is funded with an amount equal to the exemption. The survivor gets the income from the trust and the assets in the trust pass to the children free of estate tax on the survivor's death. Assets above the exempt amount can be given outright to the surviving spouse or placed in a special marital trust for him or her. This approach may have to be altered depending on the year involved and the size of the estates.

While the 2001 Act may well result in estate tax savings, it has added many new planning complications. We invite you to contact our offices to set up an appointment so that we can properly reexamine your estate plan to help to keep your estate tax, and income tax for your heirs, to a minimum.

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