Estate Tax Repeal 2001

Introduction
On May 26, 2001, the House and Senate gave final approval to the "Economic Growth and Tax Relief Reconciliation Act of 2001" (H.R. 1836). (Click here to see the status and full text of the bill as reported on the U.S. House of Representatives web site.) Similar bills were passed the last two years but vetoed by former President Clinton. Since this was one of President Bush's major legislative goals, it is expected that he will sign the bill in the next few days.

What Does This Mean for Estate Planning?
First, the present bill does not eliminate the death tax (officially known as the Estate Tax) immediately. Rather, the tax is phased out over a 9 year period finally being entirely eliminated Jan. 1, 2010. The bill reduces the highest tax bracket to 50% (currently 55% with a small bubble at 60%) as of Jan. 1, 2002. It would then reduce the highest bracket in steps each year until 2007 when it hits 45%. In 2010, the entire tax is repealed. Simultaneously, the amount exempt from this tax is increased to $1 million (currently $675,000) in 2002, $1.5 million in 2004, $2 million in 2006, and $3.5 million in 2009.

What About the Gift Tax?
The gift tax is not repealed. Probably in response to a host of perceived loopholes whereby one taxpayer could gift assets with large built up gains to family members in lower tax brackets and, thereby, reduce income taxes, Congress has kept the gift tax in place. The exemption amount for gift taxes will only track the estate tax exemption up to $1 million and will not increase beyond that. (See Sunset Provision below for another possible reason that the gift tax was retained.)

Income Tax Offset
An aspect that isn't discussed very much is the fact that the capital gain income tax would be increased in certain circumstances which may require estate planning of its own. Under current law, upon an individual's death, most of the decedent's assets receive a "step-up" in tax basis to the fair market value of the asset at the time of death. Subject to a few exceptions, in essence, this eliminates any income tax on that asset for any pre-death appreciation for the benefit of the heir or beneficiary who inherited that asset. Under this bill, at the time of the repeal of the estate tax, only assets amounting to the first $1,300,000 of the decedent's assets would receive this step up. Assets in excess of this limit would retain the same tax basis as existed prior to the death of the decedent (often referred to as "carry-over basis"). (In the case of a surviving spouse, this limit on step up basis assets would be increased an additional $3,000,000.) Thus, in any particular estate, some assets will receive a step up in basis and some may not. Therefore, most estates above $1.3 million (and in some cases much less) will have to file information returns with the IRS.

Sunset Provision
Interestingly, this law automatically becomes ineffective Jan. 1, 2011. So, unless a future Congress affirmatively takes action, the estate tax will be repealed Jan.1, 2010, and one year later will automatically reappear with a $1 million exemption! This sunset provision could explain the rationale for keeping the gift tax in place. By retaining the gift tax, Congress would prevent taxpayers from making large tax free gifts to avoid incurring an assessment that would be caused by the future return of the estate tax.

What Should I Do with My Estate Planning?
Since even under this bill, the estate tax remains in effect until 2010, unless you want to literally "bet the family farm" that you will outlive the estate tax, one should continue to plan their estate with an eye on how to reduce or eliminate the tax. We all need to remember that "what the government giveth, it can also taketh away", as it has done previously. For example, under a 1980's tax reform act, the top tax rate was supposed to drop to 50%; it never did (at least until this bill takes effect next year) as Congress continually delayed when that reduction was to take place. Since there will be three Congresses between now and 2010, the same could easily happen with this proposed estate tax repeal. It simply depends on the future political climate, budget surplus, and various other factors.

In fact, current estate planning will now have to take into account the possibility of death before or after the tax is finally repealed. Nevertheless, at least for the short term, current estate planning should continue pretty much as we have done before this bill passed, with the possible exception of not paying any gift taxes in order to reduce the later estate tax.