Review of New Tax Changes-Economic Growth & Tax Relief Reconciliation Act of 2001
Many of you have listened with great interest to the tax changes Congress has enacted which seek to reduce and hopefully someday eliminate the Estate and Generation Skipping Transfer taxes. The new changes could potentially impact your estate plan in very dramatic ways.
The new law is quite far-reaching. While we will not attempt in this memo to cover all the changes in detail, we hope to give you some valuable information that will assist you in making sure that your estate plan is up to date with this new legislation.
INCREASED UNIFIED CREDIT EQUIVALENT:
Perhaps the most noticeable and often-discussed aspect of the new tax law (dubbed the Economic Growth and Tax Relief Reconciliation Act of 2001 – EGTRRA) is its increasing the Unified Credit Equivalent – the amount of money you can pass on to your heirs at your death. Below is a table comparing the new exemption amounts to the old:
YEAR OLD Exemption Amount NEW Exemption Amount (EGTRRA)
2001 $ 675,000 $ 675,000
2002 $ 700,000 $ 1,000,000
2003 $ 700,000 $ 1,000,000
2004 $ 850,000 $ 1,500,000
2005 $ 950,000 $ 1,500,000
2006 $1,000,000 $ 2,000,000
2007 $1,000,000 $ 2,000,000
2008 $1,000,000 $ 2,000,000
2009 $1,000,000 $ 3,500,000
2010 $1,000,000 UNLIMITED
2011 $1,000,000 $ 1,000,000
You will note that as enacted, the new tax law is set to eliminate estate taxes for ONE YEAR ONLY – 2010. That is because EGTRRA includes what is called a sunset provision. This provision provides that the changes in the tax law created by EGTRRA will not apply to estates created after December 31, 2010. Essentially, under the current law, the estate and generation-skipping transfer taxes will only be repealed for a twelve-month period beginning January 1, 2010 and ending December 31, 2010.
Because the repeal of the estate tax is largely contingent on the budget surplus meeting current projections, this sunset provision allows Congress to come back later and evaluate the state of the budget surplus and decide whether repeal of the estate tax is prudent. If the estate and generation-skipping transfer taxes are to be permanently repealed, sometime before 2011, Congress would have to affirmatively re-repeal the taxes. If Congress does not take any action, then on December 31, 2010, the estate tax repeal provisions will “sunset”, and on January 1, 2011, the estate and generation-skipping transfer taxes are reinstated, with the terms and provisions of today’s tax law.
CHANGES IN ESTATE, GIFT AND GST TAX RATES:
In addition to increasing the unified credit equivalent, EGTRRA provides for decreases in the estate tax rates, as well as the highest gift tax rates and the rates of taxation on generation-skipping transfers. EGTRRA also increases the generation skipping transfer tax exemption amount, and reduces the state death tax credit. Upon complete repeal of the estate tax, EGTRRA reduces the maximum gift tax rate to 35%, and introduces a modified carryover basis for assets received from someone dying after December 31, 2009. The modified carryover basis will be discussed below.
Currently, the highest estate tax bracket is 55%. In 2002, this bracket is immediately reduced to 50%. It is then reduced by an additional 1% each year until 2007, when the highest estate tax bracket will be 45%. The highest estate tax bracket will remain at 45% until 2010, when the estate tax is repealed. The highest gift tax rate and the tax rate on generation-skipping transfers are also reduced, mirroring the deduction in the highest estate tax rate.
Beginning in 2002, the generation-skipping transfer tax exemption will be the same as the Unified Credit Equivalent amounts indicated in the table above.
While EGTRRA provides for the complete repeal of the estate and generation-skipping transfer taxes after December 31, 2009, it does not repeal gift taxes. Currently, the highest gift tax rate is 55%. This tax rate decreases at the same rate as the highest estate tax bracket until December 31, 2009, when it is ultimately reduced to 35%.
MODIFIED CARRYOVER BASIS:
Finally, upon the repeal of the estate tax, EGTRRA introduces a modified carryover basis for assets received from an estate. Under current law, and until December 31, 2009, a decedent’s assets receive a step-up in basis to the assets’ fair market value as of the decedent’s date of death. The step-up in basis is favorable for highly appreciated assets with a low basis – such as founder’s stock in a closely held business. If a beneficiary receives such assets and sells his interest shortly after acquiring it from the estate, gain he recognizes on the sale is minimized.
On January 1, 2010, such assets will no longer receive a step-up in basis and will thereafter receive a modified carryover basis. A modified carryover basis means that the beneficiary will receive the decedent’s basis in any property received from the decedent’s estate. So when the beneficiary later sells property he received from a decedent’s estate, his capital gains tax liability will be calculated by subtracting from the sale price what the decedent actually paid for that property, not what it was actually worth when the beneficiary received that property from the estate. This can result in much higher capital gains tax liability than expected.
There are a few exceptions to the new modified carryover basis provisions. The first $1.3 million dollars in a decedent’s estate will still receive a step-up in basis to the fair market value as of the decedent’s date of death. Additionally, another $3 million in assets can receive a step-up in basis if they pass to the decedent’s spouse. Any assets over $4.3 million dollars receive a carryover basis.
HOW DOES EGTRRA AFFECT YOUR ESTATE PLAN?
If your trust is drafted to provide for a marital trust and family trust after your death, the increase in the applicable exclusion amount will increase the size of your family trust. Any assets you have over the applicable exclusion amount will be held in the marital trust.
Also, it will be your trustee’s responsibility to allocate which assets receive the step-up in basis and which receive the carryover basis. It is now perhaps more important than ever to leave clear instructions to your trustee as to which assets should receive the more favorable treatment. The decision for allocating basis will be critical over the next ten years.
It is important for you to review your current estate plan and make sure that you are comfortable with the potential increase in the size of your family trust, and the decrease in the size of your marital trust. It is also very important that you assess the nature of the assets in your estate and decide how your trustee should make basis decisions that will have a significant impact on your family’s legacy.
Although it is easy to assume that you will live until the estate tax is actually repealed, we urge you not to make that assumption. Your estate may be subject to estate tax up to 2009. After 2009, in light of the sunset provision, it is a still very real possibility that the estate tax may not be repealed.
This memorandum merely sets forth the changes brought about by EGTRRA. It does not address how those changes will specifically affect your personal estate plan. In order to do that, we would need to meet with you and review your estate plan.
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