2001 Estate Tax Relief Act – Estate and Gift Tax Changes

July 27, 2001

You may have heard that Congress has changed the rules of the estate and gift tax as part of the 2001 Tax Relief Act. In an effort to keep our clients well informed, this letter summarizes and sets forth a few general implications of the new law so that you can determine (with our help if you like) what effect, if any, the new tax law will have on your current estate plan.

I. Summary of the New Law

Congress tinkered with two basic elements of the estate tax: (1) the “free amount” and (2) the top estate tax rates. By “free amount” we mean the amount that can be transferred to someone other than your spouse without any estate tax having to be paid. The new law gradually increases the free amount and reduces the top estate tax rates over the next nine years, finally repealing the estate tax (but not gift tax!!) in the year 2010. Curiously, the estate tax repeal is only for one year. That is, the House, the Senate and the President need to agree in the year 2010 to extend the repeal, and if they are unable to do so, the estate tax is reinstated pursuant to the laws in effect as of 2001! In short, if you survive the next nine years, the free amount drops back to $1,000,000, and the maximum estate and gift tax rates return to 55%.

The increased free amounts and reduced top rates are phased in over the next nine years as follows:

Top Estate Tax Rate
Estate Tax “Free Amount”
Gift Tax “Free Amount”
50% $1,000,000 $1,000,000
49% $1,000,000 $1,000,000
48% $1,500,000 $1,000,000
46% $1,500,000 $1,000,000
45% $2,000,000 $1,000,000
45% $2,000,000 $1,000,000
45% $2,000,000 $1,000,000
45% $3,500,000 $1,000,000
Repeal Repeal $1,000,000
55% $1,000,000 $1,000,000

You will note that while the estate tax “free amount” increases beyond the $1,000,000 mark in 2004, the gift tax “free amount” stays at $1,000,000. Also, keep in mind that gift tax is not repealed in the year 2010 and at such time there will be a flat gift tax rate of 35%. Finally, the generation skipping transfer tax “free amount” increases in the same manner as the estate tax “free amount” and is repealed for one year only, along with the estate tax, in 2010.

The trade off for repeal of the estate tax was the loss of a step-up in income tax basis at death. Current law provides that capital gains tax is washed away upon death (i.e., in most instances your heirs do not have to pay capital gains tax on the pre-death appreciation of assets that are sold after your death). This changes for persons dying in the year 2010, when property acquired from a decedent will retain the decedent’s tax basis. This is known as “carryover” basis. When the recipient of the property eventually sells it, he or she will need to compute the gain using the decedent’s adjusted basis. The legislation contains two major exceptions to carryover basis. First, each estate receives a $1.3 million increase in basis. Second, an estate is entitled to an additional basis increase of up to $3.0 million for property passing to the surviving spouse.

II. Estate Planning Implications of New Law

  • Planning is difficult when the law is changing and its future is uncertain. There are more variables now. Not only is the law scheduled to change nearly every year between now and 2011, but there is additional uncertainty over whether and when Congress will make additional changes to the law. Remember, 2004 and 2008 are Presidential election years.

  • We recommend you continue lifetime giving programs (i.e., hedge your bets against the reinstatement of the estate tax in 2011). We do not, however, recommend you pay gift tax unless you are unlikely to live until 2010. Keep in mind that your gift tax free amount increases to $1,000,000 in 2002 but does not thereafter increase. I know some of you have given away your entire current $675,000 estate and gift tax free amount. Come January 1, 2002, you will be able to give another “big” gift of $325,000. If you are unlikely to need this amount, gifting it in 2002 will leverage the benefit of this increase, in that all appreciation on this amount will occur outside of your estate.

  • Lifetime charitable gift planning is unlikely to change, since much of it is income tax driven. Charitable remainder trusts will still be valuable tools for eliminating the tax on appreciated assets, while at the same time converting those assets into a lifetime income stream.

  • Detailed planning for carryover basis in 2010 is probably premature in most cases, but begin record keeping that will aid in the proof of basis (i.e., knowing the basis of your assets is going to be more important than ever).

  • Unrelated to the Tax Relief Act, the IRS changed the rules with respect to retirement plan beneficiary designations and minimum distribution elections (required when a person turns 70 ½) in early January of this year. Many of you will benefit from the new rules; therefore, reviewing the beneficiary designation on your IRAs and qualified retirement plans is particularly timely, especially for those of you with big retirement accounts (to the extent they may still be considered “big” after the stock market “correction” of 2000-?)

Generally, we recommend you come in for an estate plan review every 3-5 years or at any time there is a significant change to your family, health or finances. Given the sweeping new changes to the law, we recommend you visit us sooner rather than later so that we can ensure your estate plan is still appropriate for you and your family. While most of the plans we have created in the past ten plus years are appropriate for the next nine years, each case is different and warrants careful review. If you wish to schedule a visit, please call our Office Manager at (206) 583-0155 ext. 0.