CONGRESS FINALLY REPEALS DEATH TAX--OR DOES IT?
(6/17/01)

As everyone knows, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (the Tax Relief Act) on June 7, 2001. The effects of this new law are significant.

Will the Tax Relief Act Affect Me?

To some extent, the Tax Relief Act will affect everyone. Before I tell you how, let me start by apologizing to you for what follows. I usually try not to bore you with these columns, though I'm not always successful. This time I'm not making any promises. Tax law is NOT the most exciting thing since sliced bread. Heck, it doesn't even compare to the blurbs in READER'S DIGEST. But since every one of us is affected by the new tax law in one way or another, it only seems fair to give you an overview of its key estate and gift tax provisions.

The Tax Relief Act has already caused significant changes in the way we look at estate planning, especially when it comes to the more complicated techniques and strategies used for clients with complex estates. Let's look at some of its provisions:

Increase in exemption amounts*, phase out in 2010, with sunset as of December 31, 2010

*Terminology to refer to the largest amount which may be transferred free of federal estate tax varies throughout the Act. For simplicity in this article, we have used the terminology 'exemption' to describe the largest amount transferable free of tax. [Table provided courtesy of Cowles Legal Systems, Inc.]

As you can see from the table, the exemption amounts increase much quicker under the new law than they did under the law we have been living with since 1997. The problem is that the new law contains a "sunset" provision that has been overlooked in much of the press hype. This sunset provision says that unless Congress passes new legislation before then, this Tax Relief Act "expires" on Jan. 1, 2011, and we are thrown back into the 1997 law.

Obviously, everyone hopes new legislation will be passed, but we cannot plan our estates on "hope." There just isn't any way of predicting what a future Congress will do, if anything. We have to rely on the law before us, which says that on January 1, 2001, the tax exemption will drop back to $1,000,000 (the rate that would have been reached under the 1997 law in 2006).

There is a great deal of confusion about what all these changes really mean to you and me. As I tell my clients, if you need assistance with estate planning now, you are going to continue to need assistance in the future unless Congress passes new legislation--and we have no idea if, when and what will happen in that arena.

If you have a taxable estate today, one in the $675,000 range, it will grow to $1,100,000 in 2011 if you only achieve a 5% growth rate. That means you will have the same need for tax planning then as you have now.

I heard the rules on Capital gains and
step-up-in-basis have changed. What's this mean?

I haven't read this in great detail, but let me give you my best guess. Originally, it looked as if this change would hurt a lot more people than the repeal of the "death tax" would help. Congress realized this and made some last minute changes which ameliorate this harmful effect.

Let me explain what I mean. On January 1, 2010, you will no longer inherit property at its "stepped up" basis as of the date of death. Instead, the basis of this inherited property will be the lesser of its carry-over basis or its fair market value on date of death. Now if this was all the law said, we would all be in trouble. For example, if your folks bought property many years ago for $20,000 and it was now worth $200,000, you would be looking at a hefty capital gains tax on your "profit" of $170,000. Since most of this gain would be the result from inflation and not "real money," taxing it would seem to be patently unfair.

Fortunately thoughtful heads in Congress prevailed and the final Act contains exceptions which help offset this unfair tax. The first allows you to increase the basis of inherited property by up to $1.3 million. The other allows you to increase the basis of property transferred to a surviving spouse or a QTIP trust by an additional $3 million.

The effect of these two changes is that you can, in the right situation, avoid capital gains taxes on up to $4.3 million worth of property if you die leaving property to your surviving spouse.

Most of us won't acquire assets approaching these elevated levels, so just ignore the rest of this paragraph. For those of you unfortunate enough to have to deal with this problem, you need to think about capital gains when you decide who will get what at your death. Your executor is going to have to select the property that receives this step up in basis and only property you own at your death will qualify. If you acquired something within three years of your death and didn't pay full value for it, you can't step up its basis. Don't leave such property to your spouse as you risk losing part of his or her $3 million step up. Be sure you leave qualified property to your spouse so he or she receives the full benefit of this step up in basis.

That's enough for now. Next week I'll tell you more about the Tax Relief Act. Stay tuned for some exciting reading.

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