The Economic Growth and Tax Relief and Reconciliation
Act of 2001 (the "Act") made substantial changes in
the Internal Revenue Code as it effects estates and gifts. The
purpose of this article is to discuss some of these changes
and how personal estate planning may require modification in
light of the changes.
One of the best publicized changes under the Act is the increase
in the amount that can pass free of estate taxes, commonly referred
to as the "estate tax exemption amount". Under the
Act this amount increased to $1 million for 2002 and 2003. This
means that taxpayers may transfer $1 million of assets free
of estate tax. Transfers in excess of this amount are subject
to estate tax. The estate tax exemption amount is scheduled
to increase throughout the decade to a maximum of $3.5 million
in 2009. In 2010 estate taxes will be repealed. In 2011 estates
taxes return and the estate tax exemption amount will again
be pegged at $1 million.
For the first time since 1976 the estate tax exemption amount
and gift tax exemption amount are no longer unified. Beginning
in 2002, the gift tax exemption amount increased to $1 million,
meaning that a taxpayer could choose to make lifetime gifts
of up to $1 million on a tax-free basis. By doing so the taxpayer
is essentially choosing to use his or her estate tax exemption
amount during lifetime instead of at death (or in a combination).
However, beginning in 2004, the estate tax exemption amount
increases to $1.5 million but the gift tax exemption amount
remains at $1 million throughout the decade (even in 2010 when
estate taxes are repealed).
Tax rates applicable to gifts and estates exceeding the taxpayer's
exemption amounts are subject to a graduated rate structure.
The Act reduced the highest tax rate from fifty-five percent
to fifty percent and repealed a higher sixty percent rate applicable
certain very large estates. The highest marginal tax rate will
decrease throughout the decade to forty-five percent in 2009.
However, the highest fifty-five percent rate returns in 2011.
An unlimited amount may be given to a spouse during lifetime
or at death without the imposition of gift or estate taxes.
This is referred to as the unlimited marital deduction. However,
the unlimited marital deduction is not available to non-citizens.
Also, certain types of gifts to qualified charitable organizations
continue to be excluded for purposes of calculating a gift or
estate tax.
It is important to remember that all assets passing at the
time of death are subject to imposition of estate taxes. Estate
taxes are not limited to assets passing under probate administration.
Consequently, life insurance, retirement plan benefits, annuities,
IRAs, jointly held accounts, and assets passing under a community
property agreement or revocable living trust are all subject
to estate tax. While most life insurance proceeds pass free
of income tax, such proceeds are included in your estate for
purposes of estate taxes; however, steps can be taken to avoid
this result.
For married couples with estates that exceed (or are likely
to exceed) the estate tax exemption amount, it is important
to include appropriate provisions in wills or living trusts
to preserve the estate tax exemption of the first spouse to
die. If all assets pass to the survivor under the unlimited
marital deduction, the decedent's estate tax exemption is lost.
This will result in the children (or other beneficiaries) paying
substantial additional estate tax. The changes required to avoid
this extra tax liability are relatively simple, low cost and
require few changes in how you own your assets.
Most estate attorneys, accountants and financial planners view
the Act with only modest enthusiasm. "Smaller" estates
are benefited because of the immediate increase in the estate
tax exemption amount to $1 million from its previous $675,000.
Larger estates are also benefited with the decreasing highest
marginal tax bracket. However, all of these benefits are relatively
short-lived under the Act. Increasing real estate prices, a
recover in the stock market and growth of retirement plan benefits
continue to add to the size of estates and push an increasing
number of estates into the "taxable" category.
Furthermore, at the present time it appears that the state
of Washington will continue to tax estates of less than $1 million.
Like many other states, Washington imposes as an estate tax
the amount that the Internal Revenue Code allows as an credit
against the payment of any state death tax. This is referred
to as the "state death tax credit". Thus, a portion
of the tax that is otherwise payable to the United States Treasury
is actually paid to the state of Washington.
Until 2001, Washington's estate tax amount allowed the use
of all credits available under the Internal Revenue Code including
the estate tax exemption amount. In essence, Washington allowed
the same estate tax exemption amount that the Internal Revenue
Code authorized to the estate. However, due primarily to budgetary
constraints, Washington will not be raising the estate tax exemption
amount in lock-step with the increase under the Internal Revenue
Code under the Act. Under the law existing prior to the Act
the estate tax exemption amount was scheduled to increase to
$700,000 for 2002 and gradually increase to $1 million in 2006.
At the present time it appears that Washington will be following
this pre-Act law. Consequently, estate of persons dying in 2002
will be subject to estate tax in Washington if the value of
their estate exceeds $700,000, not the new federal estate tax
exemption amount of $1 million.
As indicated above, many married couples have included provisions
in their wills or living trusts to fully utilized both spouse's
estate tax exemption amounts. Depending on how this planning
objective was accomplished, there may now be an estate tax payable
on the death of the first spouse to die, not just on the survivor's
death, as a consequence of the Washington's failure to recognize
the increase in the estate tax exemption amount under federal
law. To avoid this the will or living trust must be modified
accordingly. You should have your will or living trust reviewed
by your attorney to determine if this consequence was anticipated
at the time the documents were drafted.
In another dramatic departure for prior law, the Act essentially
eliminates the "step-up in basis rule" beginning in
2010. Historically, most forms of assets that had appreciated
in value during the owner's life received a step-up in basis
to fair market value as of the date of the owner's death. This
allowed the recipients of the decedent's estate to avoid the
payment of a capital gains tax that the owner would have had
to pay if he or she sold the property prior to death. Beginning
in 2010, the recipient's of property for a decedent will receive
be required to retain the owner's basis in the property.
However, the Act does allow a limited basis step-up in the
amount of $1.3 million of appreciation. This basis step-up is
allocated among the property of the estate in the discretion
of the estate's executor or trustee. If the decedent is survived
by a spouse, the basis step-up in allowed to the extent of $3
million of appreciation; however, qualifying for the additional
amount allowed to a spouse may be complicated in many cases.
Certain transfers to grandchildren and other beneficiaries
when the decedent or donor "skips" a generation are
subject to an additional tax called the generation skipping
transfer tax (GSTT). The purpose of the GSTT is to tax transfers
that skip generations because the assets will not be included
in the estate of the skipped generation, such as children. Most
commonly this occurs when a grandparent makes substantial gifts
to a grandchild. The highest marginal estate tax rate applies
to GSTT transfers. However, there are several techniques available
to avoid the application of GSTT. In addition, every donor has
a $1 million exemption that may be allocated during lifetime,
at death or a combination. Under a 1997 law this exemption was
be indexed to inflation, rounded to the nearest $10,000 and
now stands at $1,100,000. Beginning in 2004 the GSTT exemption
will be the same as the estate tax exemption amount. The GSTT
rules are complicated, especially involving the allocation of
the exemption, so you should consult your attorney or accountant
before making large gifts, during lifetime or at death, when
a generation is skipped.
As most people know, certain gifts of $10,000 per year are
free of gift tax. This is referred to as the annual gift tax
exclusion. This amount was indexed to inflation, rounded to
the nearest $1000, and is now $11,000.
In addition to these changes in the federal tax law, there
have been many improvements to the Washington state law dealing
with estate planning. The probate code has been substantially
modified to allow for increased efficiency in the administration
of a decedent's estate. The law affecting powers of attorney
to handle a disabled or incapacitated person's financial affairs
and health care has been improved as well. Your wills, trusts,
power of attorney and other estate planning documents should
be reviewed to ascertain whether modifications are prudent to
take advantage of these and other changes in the law.
Overall, the Act, as it pertains to estate planning, has some
benefits but also adds many complications and a substantial
degree of uncertainty. Higher exemption amounts and decreased
rates are beneficial to estates for only a short period of time.
Estate plans will need to be reviewed more frequently to determine
if modifications are necessary in order to take full advantage
of the benefits under the law. Clients and their professional
advisors should discuss these and other changes under the Act
to determine how each individual's estate plan is affected.
©Copyright 2003, Landerholm, Memovich, Lansverk & Whitesides,
P.S.
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