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Estate and gift tax changes under the Economic Growth and Tax Relief Reconciliation Act of 2001
By Carol I. Katz
Director of Tax Services
Leonard J. Miller & Associates, Chartered
Member, MACPA Trust, Estate and Gift Tax Committee
Although touted by Congress as a repeal, the estate tax is still very much in place. The Act repeals the estate tax for one year, 2010, and allows the current estate tax rules, rates and exemptions to come back in force in 2011 under what is known as a "sunset" provision. In fact, the sunset provision does away with the provisions of the entire Act in 2011 (if the provisions are actually still in existence at that time).
The new law provides that the estate tax continues although with an increasing exemption from $1 million to $3.5 million through 2009.
The phase out of the estate tax will follow a relatively slow timetable:
Year | Top estate tax rate | Exemption |
2002 | 50 percent | $1 million |
2003 | 49 percent | $1 million |
2004 | 48 percent | $1.5 million |
2005 | 47 percent | $1.5 million |
2006 | 46 percent | $2 million |
2007 | 45 percent | $2 million |
2008 | 45 percent | $2 million |
2009 | 45 percent | $3.5 million |
2010 | Repealed | N/A |
2011 | 55 percent | $1 million |
Tax planning impact
Almost all wills will have to be modified to make certain their provisions do not inadvertently disinherit the surviving spouse (by the funding of the "by-pass" provisions) and cause legal petitions for the state statutory elective share. Use of disclaimer provisions in wills will increase to give more latitude in decision making during the phase-in time period. Reasons for having many trusts (such as spendthrift trusts and special needs trusts) will remain valid and should continue to be implemented when necessary.
Charitable giving could be negatively impacted due to the estate (and income) tax rate decrease. This would be the case when taxpayers are merely making donations because of the techniques that use tax benefits as their appeal, such as Charitable Remainder Trusts. Taxpayers with estates of $3.5 million and less may become even more resistant to making lifetime gifts. Decisions regarding current amounts of life insurance coverage and future purchase of policies will become more complex.
Modified carryover basis: A complicated accompaniment to the repeal is the institution of what is known as a modified carryover basis rule that would replace the current step-up (to fair-market value) basis provisions. This then changes the estate tax to become more of an income tax problem. There are two exceptions that will help mitigate this rule for many estates:
- $1.3 million of basis will be allowed to be added to certain assets; and
- $3 million of basis will be permitted to be added to assets transferred to a surviving spouse.
However, not all property is eligible for an increase in basis. Property acquired by a decedent by gift from a non-spouse less than three years before death is excluded (to prevent "gifts" of low basis assets in anticipation of stepped-up bequests). Also, property that constitutes a right to receive income in respect of a decedent (IRD) is excluded. Stock in a DISC and certain foreign companies also is ineligible for an increase in basis.
Tax planning impact
A record keeping compliance nightmare is in store for anyone trying to come up with basis for asset purchases that could go back more than half a century. Any CPA that prepares income tax returns knows what trouble getting correct stock basis can be, and can just imagine trying to get basis for all inherited assets.
The gift tax remains in place: To curb significant use of gifts to transfer property from higher to lower rate taxpayers, as well as to escape estate taxes entirely, the new law retains a gift tax, keeping the applicable credit amount at $1 million from years 2002-2009 and using the same rates as the estate tax. After 2009, gifts in excess of a lifetime $1 million exemption would be subject to a gift tax equal to the top individual income tax rate at that time.
State tax credits phased out: The state death tax credit allowed against estate tax will be reduced by 25 percent in 2002, 50 percent in 2003, 75 percent in 2004, and completely repealed — replaced by only a deduction for death taxes. (This could have a significant negative impact on state revenue for those states, such as Maryland, that receive the "pick-up," or "sponge" taxes equal to the credit under current law).
Other estate tax relief:
- The Qualified Family-Owned Business deduction is repealed for taxpayers dying after 2003.
- The new law expands the availability of qualified conservation easements to remove requirements for proximity to national parks, wilderness areas, and non-urban areas.
- The generation-skipping transfer tax rules are modified so that after 2003 the amount exempt from GST is the same as the amount exempt from the estate tax with the same estate tax rates applying. New rules apply for "deemed" allocations.
- The availability of the installment payment rules are expanded to qualified lending and finance business interests and certain holding company stock.
- Refunds in connection with the application of net cash lease provisions for spouses and lineal descendants are restricted.
Tax planning impact
Full employment for CPAs versed in estate, gift and trust family tax planning, and constant monitoring of future legislative law changes that are virtually certain to be enacted.
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