Congress Passes Estate and Gift Tax Changes

By Andrew J. De Maio, Esq.

On May 26, Congress completed work on a major revision of the estate and gift tax laws. Although widely touted as the repeal of the federal estate tax, many question, for reasons explained later in this article, whether a complete repeal will ever take place. The estate and gift tax changes are part of the Economic Growth and Tax Relief Reconciliation Act of 2001, the most sweeping overhaul of the federal tax laws in the past 20 years. President Bush has promised to sign bill.

Major Changes

The law makes several key changes in the estate and gift tax area:

• Increases the lifetime estate and gift tax exemption from the current level of $675,000 to $1 million, effective January 1, 2002.
  
  
• Provides for a gradual increase in the exemption and a decrease in the maximum estate tax rate between 2002 and 2009. This table summarizes the changes:

Year	Exemption Amount	Maximum Estate Tax Rate
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2010	REPEALED	REPEALED

• Provides for total repeal of the estate and generation-skipping transfer tax effective for decedents dying after December 31, 2009. However, the law provides that the repeal, along with all of the other changes, are reversed one year later, on December 31, 2010. At that time, in the absence of future action extending the repeal, all of the estate and gift tax laws in effect in 2001 will spring back into effect. This "sunset" provision is a byproduct of the budgetary cost estimation process and procedural rules in the Congress.
  
  
• Increases the exemption against gift tax to $1 million. Even after the estate tax has been repealed, the gift tax will remain in effect, subject to the $1 million lifetime exemption and a reduced set of rates.
  
  
• Gradually reduces the state death tax credit between 2002 and 2004, and eventually (effective January 1, 2005) converts it into a deduction rather than a credit. Current law allows to each estate a dollar-for-dollar credit against federal estate tax for any inheritance tax or other death tax imposed by a state government, up to a maximum amount that varies with the size of the estate. As a result, any state death tax imposed up to the federal limit is a "painless" tax, because it is fully offset by the federal credit. All 50 states have enacted as special tax that is equal to the amount of the credit. The new law will reduce and eventually eliminate state revenues from this source.
  
  
• Repeals the complex deduction for family owned businesses, effective January 1, 2004.
  
  
• Changes the exemption against generation-skipping transfer (GST) tax so that it equals the amount of the exemption against estate tax shown in the table above. Currently, the GST exemption is $1 million, indexed for inflation.
  
  
• Imposes a "carryover basis" rule at death contemporaneous with repeal of the estate tax in 2010. Under this provision, the income tax basis of assets held at death will no longer be "stepped up" to their fair market value as of that date. There are two exceptions to the carryover basis rule: a $3 million exemption for assets passing to a surviving spouse, and a $1.3 million exemption for transfers to anyone else. There are complex rules for allocating the allowable basis increase among estate assets.
  
  
• Allows estates, revocable trusts and heirs to take advantage of the income tax exclusion for capital gains realized on the sale of a personal residence. Currently the exemption of $250,000 ($500,000 for a married couple) is not available after the death of the owner of the residence.
  
  
• Simplifies the rules governing GST tax.
  
  
• Eases the requirements to qualify for favorable estate tax treatment of conservation easements.
  
  
• Makes it easier to qualify for special payment of estate tax in installments when an estate owns a family business.
  
  

Implications

These sweeping changes, many not effective for years to come, will require that all estate plans be reviewed. We'll discuss some of the more common patterns in a future issue. Meanwhile, painted with a broad brush, here is a look at some likely consequences of the new legislation.

The political wrangling isn't over. After repeated unsuccessful attempts and years of negotiation, Congress has finally acted. But that doesn't mean the future is certain. Most of the estate and gift tax changes won't take effect for years. That gives ensuing congresses and presidents plenty of opportunity to revisit the estate tax issue and change the rules again. Many observers believe that complete repeal of the estate tax will not take place as scheduled in 2010. As economic conditions, budget projections and political conditions change, future legislation may delay or undo the repeal.

Fewer estates will be subject to estate tax. Although repeal of the estate tax is far from a foregone conclusion, the law provides for an immediate increase in the estate tax exemption. That means fewer estates will be subject to estate tax, and those that are will pay less tax.

Reeling from loss of revenue, the states will react to the loss of the state death tax credit. According to a March 2001 report published by the Center for Budget and Policy Priorities, state governments collectively stand to lose billions of dollars of revenue when the state death tax credit is fully eliminated in 2005. It is conceivable that some will make up for the loss by hiking or enacting inheritance taxes.

FORESIGHT is a publication of De Maio & De Maio, Attorneys at Law. It is not intended as and does not constitute legal advice, nor does it create an attorney-client relationship. The information contained in this publication should not be acted upon without first obtaining the advice of a professional advisor.

De Maio & De Maio is a law firm located in central New Jersey.  We provide legal services in the areas of estate planning and administration, tax planning, business formation and transfer, trust administration, and related fields.

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