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C A L O N E L A W G R O U P, L L PEstate Tax Repeal
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Back to Articles & Publications Hooray, the Economic Recovery and Taxpayer Relief Act of 2001 (The 2001 Tax Act) is finally here! Assuming President Bush will sign it, we can now finally get on with figuring out how all the rhetoric played out. But you know the saying, if you like sausage or laws, don't watch either of them being made. This truism clearly applies to the 2001 Tax Act. After all the hullabaloo, I expect there will be disappointment on all sides with many of the provisions. This article will examine the real story of the estate tax "repeal" insofar as it survived the Congressional meat-grinder. The Senate Bill was more balanced between the goals of the Republicans and Democrats than the House version, and many of the changes made by the Senate were kept in place in the committee reconciliation to ensure final passage. As a result the final 2001 Tax Act is as fine a sausage as was ever produced by Congress. While touted as a "repeal" this hardly seems to be the correct adverb to describe the effect of the new act. Unless all the stars align correctly in the year 2010 for continuation of the program, what the new act really does is provide for a temporary, periodic increase in the estate tax exemption amounts and a reduction in the maximum estate and gift tax rates, with a potential repeal of the estate tax in the year 2010. If Congress truly meant to permanently repeal the tax, they would have left out the provision which reinstates the current estate and gift tax system in 2011. Under the new act, the estate tax exemption increases periodically, commencing with an estate and gift tax exemption of $1,000,000 per person in 2002 and 2003. The estate tax exemption (but not gift tax) increases to $1,500,000 per person in 2004 and 2005, increases again to $2,000,000 per person for 2006 through 2008, and finally increases to $3,500,000 per person in 2009. In 2010 the estate tax is "repealed," but only for a one year period. In 2011 the estate and gift tax system automatically reverts back to the current system (including an estate and gift tax exemption of $1,000,000 per person) and a top effective marginal bracket of 55%, unless Congress and the President act to continue the "repeal" prior to that time. In addition to increasing the exemption amounts, Congress also reduces the maximum estate and gift tax rates. New rates are phased in, reducing the top marginal bracket from 55% to 50% in the year 2002, then down 1% annually to 45% in the year 2007 where it stays until the "repeal" in 2010. Historically the gift tax was imposed to stop people from avoiding the estate tax by giving their property away during their lifetimes rather than at death. Since 1976, the estate and gift tax system has been a unitary system, with the exemption equivalent (currently $675,000 per person) being the same for both the estate and gift taxes. This meant each person could make combined lifetime and testamentary transfers up to the exemption equivalent amount before any estate or gift tax was imposed. The 2001 Tax Act moves away from the unitary system, placing a cap on the gift tax exemption at $1,000,000. Thus taxpayers can not give away as much during lifetime as they can at death. The only way to "take advantage" of the increased estate tax exemption amounts over the gift tax exemption would be to die sometime during the 2004 through 2010 period. Congress' failure to keep the gift tax in step with the estate tax reflects an underlying intent to minimize the true benefits taxpayers will realize under the new act. Retaining a $1,000,000 gift tax exemption through the effective period of the new act and continuing the gift tax at the maximum individual income tax rate then in effect during the year 2010 indicates that Congress does not want younger persons to take full advantage of the new act through planned lifetime giving. I can just see Congressional actuaries calculating the number of baby boomers who will still be alive in the year 2011 when the old law springs back into effect. Another subtle provision of the new act is the phase out of the state death tax credits over a four year period, ending with the repeal of the state credit in the year 2005. Presently the states each share in a percentage of the total death tax up to approximately 16% of the total death tax. Under the state pickup tax system, any state death tax paid produces a credit which reduces the Federal estate tax in equal amount. By phasing out the state credit early on in the new scheme, the Feds are forcing states to impose a new state level estate or inheritance tax system or risk losing their share of the pickup tax. Given the vanishing surplus in California and the makeup of our legislature, I can see a new California inheritance tax coming our way. My final analysis? This is truly an estate tax "repeal" that only Dr. Kavorkian could love. The only way to take full advantage of the new law would be to plan to take tea and scones with the good doctor and his iv drip in the year 2009 or 2010, depending on the size of your estate. The new act is not conducive to good estate tax planning. It does not treat people fairly to ensure that younger generation taxpayers can use the new act to the same advantage as the elderly who may die during the effective years. It does create a lot of work for tax and estate planners who will be advising taxpayers how to coordinate and revise their existing plans to mesh with the "estate tax repeal." Consult with your tax advisor on how the new law impacts you. |
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