SUMMARY OF 2001 ESTATE TAX & OTHER ESTATE PLANNING CHANGES

The "Economic Growth and Tax Relief Reconciliation Act of 2001" made significant changes in the federal estate tax, gift tax, generation-skipping transfer tax, and income tax cost basis of assets at death. The following is a summary of the changes:

Increase in estate tax exemption

The federal estate tax exemption, which was $675,000, and was due to rise to $1,000,000 in 2006, was greatly increased. The exemption is increased for the following years:

The estate tax will be totally eliminated for persons dying after December 31, 2009.

Decrease in highest estate and gift tax rates

The federal estate tax rates ran from 37-55%, with the maximum rate of 55% applying to estates with a value (including the exemption) of over $3,000,000. The top estate and gift tax rates will decline for the following years:

Starting in the year 2006 we will no longer have gradual rates, but a flat rate of 46% for the year 2006, declining to 45% for years 2007-2009.

Generation-skipping transfer tax

The exemption for generation-skipping transfers, which was $1,060,000 in 2001, dropped in 2002 to $1,000,000, but then increased to match the estate tax exemptions above. This will simplify handling of generation-skipping trusts since the exemptions in the past have been different. The generation-skipping transfer tax rate is set at the highest estate tax rate in effect when the tax is due, so this will decline from 55% to 45% in steps through 2007. The generation-skipping transfer tax is abolished, effective January 1, 2010. There are some technical changes on automatically allocating the generation-skipping transfer tax exemption including some retroactive changes.

Gift tax

The gift tax structure was modified in 2001 but was not abolished. The $10,000/year/donee exemption was subsequently increased to $11,000 in 2005 and $12,000 for 2006-2008. The lifetime exemption from gift tax, which has been tied to the estate tax exemption, was raised in 2002 to $1,000,000, but does not increase in future years to match the increase of the estate tax exemption. The gift tax exemption is not abolished in 2010 as are the estate and generation-skipping transfer taxes. The gift tax rate above the $1,000,000 lifetime exemption and the $10,000/year/donee exemption for years after 2009 will be the highest income tax rate then in force, which is scheduled to be 35%.

State death tax credit

The current estate tax structure gives a credit to the state in which the decedent lived for a portion of the tax due. This amount is currently deducted from the estate tax and paid to the state so there is no additional tax due the decedent's estate. This amount comes out of the tax due the IRS. This tax is based on a formula which can be as high as 16%.

Starting in 2002 and continuing through 2004 the state death tax credit is reduced 25% per year, expiring in 2005. It is replaced by a state death tax deduction, which comes off of the assets and not the estate tax. This would normally increase the amount of estate tax paid.

California abolished the California Inheritance Tax on June 8, 1982, and provided for the state death tax credit. Since there will be no state death tax credit for individuals dying after December 31, 2004, it is uncertain if California will be able to obtain any taxes at death.

Cost basis adjustments

After the federal estate tax is abolished on January 1, 2010, there will be a change in connection with stepped-up income tax cost basis at death. Now, when someone dies, the decedent's assets get a new basis or value at death based on the current fair market value of the assets. All prior capital gains before death are ignored. The new rules provide that the beneficiaries of the decedent's assets will no longer get a stepped-up cost basis at death. They will use the decedent's cost basis or the fair market value of assets at date of death, whichever is lower.

The executor or whoever has the assets can make an adjustment and increase the cost basis by up to $1,300,000 for assets which do not go to the spouse, and up to $3,000,000 for assets passing to the spouse. Elaborate reporting requirements are involved if the total value of the decedent's assets exceeds $1,300,000 at death. Both halves of the community property still get a stepped-up cost basis at death, subject to the above limitations.

Assets acquired by a decedent by gift or inheritance within three years of the decedent's death do not get a stepped-up cost basis of any type when the decedent dies. This takes effect for individuals who die after December 31, 2009.

Trust assets treated as gifts

Effective January 1, 2010, if an individual creates an irrevocable trust it will be treated as a taxable gift of all of the trust assets unless the trust is treated as wholly owned by the trustor or trustor's spouse.

Other changes

There are special provisions for owners of certain lending and finance businesses to pay estate taxes over a period of time; conservation easements and tax benefits for these easements have been expanded, and some other rather technical changes were made. The special valuation rules and reduction of estate taxes for farms and businesses expire for individuals dying after December 31, 2003. All of these affect very few taxpayers.

Sunset provisions

All of the above provisions automatically expire on December 31, 2010, unless Congress votes to extend them and the President approves.