Estate Tax Reform - Fact or Fiction?

The long-awaited tax reform package was signed into law on June 7, 2001. Despite the optimistic reports of tax simplification and repeal of the estate tax, the legislation provides neither simplification nor the certainty of repeal. This is a synopsis of what the 2001 Tax Act does (and does not) accomplish:

  • For calendar year 2001 – there are no changes to the existing $675,000 unified credit/applicable exclusion amount (hereinafter the “Exclusion Amount”) for federal estate and gift taxes, and no changes to the existing $1 million exemption1 from generation-skipping transfer (GST) taxes.
  • Beginning in 2002, the Exclusion Amount for federal estate tax is increased to $1 million and the highest estate and gift tax bracket is reduced from 55% to 50%.
  • Beginning in 2004, the GST exemption will increase in the same progression as the Exclusion Amount.
  • The Exclusion Amount for federal estate tax and GST tax (but not gift tax) will continue to increase and the highest estate and gift tax bracket will decrease, as noted in the table below, until 2010:

Exclusion Amounts and Rates Under 2001 Tax Act

Calendar Year Estate & GST Exclusion Highest Estate & Gift Tax Rates
2002 $1 Million 50%
2003 $1 Million 49%
2004 $1.5 Million 48%
2005 $1.5 Million 47%
2006 $2 Million 46%
2007 $2 Million 45%
2008 $2 Million 45%
2009 $3.5 Million 45%
2010 Repeal 35%2
  • The federal estate and generation-skipping transfer taxes are repealed as of January 1, 2010.
  • The gift tax is not repealed. The lifetime gift exemption is increased to $1 million as of January 1, 2002, and, after 2009, the highest bracket for gift tax purposes will be the same as the top bracket for income taxes.
  • Carry-over basis is here! A carry-over basis means that the tax cost basis of an asset in the hands of one individual, a donor/decedent, will be carried over to the recipient of the property, the donee/beneficiary. (The current law automatically increases the tax cost basis of assets received from a decedent to the values used on the Federal Estate Tax return, thus reducing or eliminating the capital gains taxes incurred when the assets are later sold by the recipients). After 2009, the basis of an asset passing through an estate will be the lesser of the tax cost basis of such property as owned by the decedent, or the fair market value of the property at the decedent’s date of death. An executor may elect for certain assets in the estate to receive a step-up in basis (setting the higher fair market value as the tax cost basis for future transactions) for an aggregate basis increase of $1.3 million. If property is passing to a surviving spouse, the executor may elect an additional increase in basis of $3 million, for a total basis increase of $4.3 million. However; marital deduction trust property will not be eligible for step-up treatment upon the surviving spouse’s death, and neither will property received as a gift by decedent within 3 years of death (other than property received from a spouse).
  • The qualified family-owned business deduction is repealed in 2004. Currently, the maximum amount of the family owned business deduction is $675,000, which must be coordinated with the Exclusion amount, allowing a deduction of no more than $1.3 million.
  • New reporting requirements are now in place for life-time giving and transfers at death. Donors and executors will be required to provide the name and taxpayer identification number for each recipient, a description of the property transferred, the adjusted basis for the property and the donor/decedent’s holding period, information to show whether the gain on a subsequent sale would be ordinary income or capital gains, and for transfers at death, the amount of any basis increase allocated to the asset.
  • The most bizarre provision in the Act is the “sunset provision.” Incredibly, all of the changes noted above will be repealed as of December 31, 2010, and the federal estate, gift and GST tax provisions effective in 2001 will return as of January 1, 2011, unless Congress intervenes! Our guess is that true repeal will never happen. ___________________ 1 As indexed for inflation. 2 Applies to gift tax only.