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Understanding
the New Death Tax

While on the campaign trail against then-Vice President Al Gore, then-Governor George W. Bush promised to slay the “death tax,” if elected President. Making good on that promise just six months into his term, President Bush on June 7, 2001 signed a death warrant for the death tax.  As part of the largest tax reduction in two decades, known as the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), this death warrant may be rather illusory given the proven resiliency of the death tax. Moreover, because of a curious provision in EGTRRA itself, the whole exercise may be like attempting to slay a werewolf with something less than a silver bullet.

Key Estate & Gift Tax Provisions

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The bill abolishes the estate tax in 2010. However, because of the “sunset provision” tax repeal could be short-lived.  Unless the law changes before December 31, 2010, the tax rates will return once again to their 2001 levels. We are about halfway into this legislation and in 2006 the estate tax exemption is $2,00,000, and will eventually increases to $3.5 million in 2009. The top estate tax rate used to be 55 percent, but has dropped gradually over the years to 46 percent this year, and will drop one more time to 45 percent. The gift tax is not repealed, but the top rate is lowered to the top individual income tax rate.

Estimated Costs

With full implementation, The Joint Committee on Taxation estimates the lost revenue to total $138 billion between 2001-2011. The annual cost of complete repeal of the estate tax is estimated at more than $50 billion.

Winners & Losers

There are winners and losers in the game of tax politics. The real winners under EGTRRA are the taxpayers with otherwise taxable estates who are fortunate enough to die between January 1, 2010 and December 31, 2010. Potentially the biggest losers will be state governments. Many states have a death tax that is tied to the maximum state death tax credit permitted for calculating federal estate taxes. Under EGTRRA, this current credit amount is reduced by 25% in 2002, 50% in 2003, and 75% in 2004. The state death tax credit is repealed effective in 2005 and replaced by a deduction for death taxes actually paid to a state. With state governments experiencing revenue shortfalls, some pundits predict this could force states to institute their own death tax regimes to replace revenues lost to repeal of the state death tax credit. Washington State implemented its own State Estate Tax, which took effect May 17, 2005.  For more detail, see brief estate tax section.  Note-->[The following link is dated 2001] For an overview of which states may be hardest hit, see the State Tax Table.

Estate Planning Decisions

For most people, some 98% of adult Americans, the fundamental issues of estate planning, including self-protection, asset protection, and asset distribution, remain unchanged. However, some people should review their planning options with qualified legal counsel to consider how these changes might impact them, including:

·         Persons Who Own Highly Appreciated, Or Rapidly Appreciating, Assets.
Some people who were never facing federal estate taxes may be hit with a capital gains tax on inherited assets, due to the loss of stepped-up basis and implementation of carry-over basis on inherited assets for tax accounting purposes.

·         Persons Involved in Lifetime Gifting Plans.
 If you are making lifetime gifts to reduce the size of your estate, whether through outright distributions, in trust, or through a business entity such as a Family Limited Partnership, it may be wise to review this strategy in light of the scheduled increases in the unified credit and the changes in tax basis for inherited assets. Any gifting strategy that prematurely removes assets from your estate should be reviewed on a regular basis.

·         Couples Who Have Implemented Certain Estate Tax-Avoidance Strategies.
For instance, as the unified credit increases, some couples who were concerned about federal estate taxes may no longer be subject to the tax – providing they die at the appropriate time. Some plans may have to be amended, especially if the plan included formulas to avoid federal estate taxes by maximizing the use of the unified credit for the first spouse to die.  This strategy could result in over-funding of the family trust, while possibly under-funding the marital trust.

·         Business Owners Planning to Use the Qualified Family-Owned Business
      Interest (QFOBI) Deduction.
The complex QFOBI deduction would be repealed in 2004. However, the 10-year recapture period for special use valuation could apply even after repeal of the estate tax until the expiration of the 10-year period.

Because of the uncertain nature of the future of the federal estate tax, individuals, families and business owners should insist on flexible planning options, stay in touch with their legal advisors, and review their plans regularly.

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