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By John M. Bigler The largest tax reduction in twenty years was passed by Congress and signed into law by President Bush at the beginning of this month. The new law affects not only Federal income tax but also the Federal estate tax. After several years of debate on the subject, the Federal estate tax will be gradually phased out between now and the year 2010. I'd like to examine some of the provisions of the new tax law.
The individual exemption for estate tax is currently $675,000 for the year 2001. This means that the estate tax is only applied to dollars passing by inheritance over $675,000. The individual exemption will rise to $1,000,000 in 2002 and gradually each year after that, until 2010 when the tax will be eliminated. The rates will fall during that period until the year 2010 as well, from a top rate of 55% this year to 50% in 2002. It is important to note that, while the estate tax is in the process of being done away with, it will continue to be operative for several more years. The same estate preservation techniques must continue to be used, even though the tax will fall a little less harshly in each of the coming years.
Although the estate tax has been repealed and will disappear in the near future, the gift tax will remain in place. The government is always concerned about people giving their assets away to others, such as to their children or other family members, in order to take advantage of lower tax brackets. A child with no other income of his own will pay lower taxes on the same amount of money than his parents would. In order to remove that option of shifting income so it will taxed at lower rates, the I.R.S. will retain the current higher rates for gifts.
One of the major reasons for making use of the gift tax exemption has been to minimize the size of an estate in order to avoid that tax at death. Someone starting early enough could be able to distribute assets through gifts during their lifetime, with little or no tax consequence, accomplishing much the same effect as they would have wanted through a Will. With no estate tax to avoid in a few years, that tool will no longer be necessary. The repeal of the estate tax removes that reason to make gifts and makes the continuation of the gift tax a bit easier to accept.
The lifetime exemption for gifts will rise, along with the estate tax exemption, to $1,000,000 under the new law. Up until now the gift tax exemption and the estate tax exemption have been a unified amount. Gifts of over $10,000 to any person in a given year would count against the estate tax exemption.
Among the many other changes to the tax code is a new modified method of determining the tax basis of inherited property. In the past, inherited property would have received a step-up in tax basis to the fair market value at the time of death. This could potentially save heirs very large amounts on capital gains taxes when they sell property they have inherited. For example, a house purchased for $30,000 thirty years ago and now worth $250,000, which would otherwise create a taxable capital gain of $220,000 for the heirs, instead carries no tax because heirs automatically receive the property with a basis equal to its value on the date of death. In other words, their taxable capital gain would be zero.
In exchange for some of the other relief provided by the new tax bill, the step-up in basis is no longer automatic for all inherited assets. There is a limit, although a large one, on the value of assets that can receive this preferential treatment. Three million dollars of assets passing to a spouse, and a total of $1.3 million of assets passing to persons other than a spouse can have a step-up in basis to the date-of-death fair market value.
The new tax laws will make it somewhat easier to pass on what you have built up over a lifetime to the people you care about. It is important to remember, however, that if you have already done estate planning, it might be worthwhile to review those plans with the new tax laws in mind. It may be that the estate tax forced you to make compromises about the dispositions you would have preferred to make. If so, it would be a good thing to take a fresh look at your estate, knowing that the looming presence of the estate tax will soon be removed.
Reprinted with permission of the Suffolk Times © 2003
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The estate tax has been a very important factor to consider for people planning how their assets are to be disposed of, both during life and after death. With rates of up to 55%, the estate tax can take a very large bite out of an estate. Over the next nine years, the Federal estate tax will shrink year by year until it is finally completely inoperative. This change will require thought by those who have already made provisions to try to allow as much of their estate as possible to pass to their heirs, as well as those who have not yet taken any action. The removal of this overshadowing presence at the end of life will allow people to make plans for their estate more in accord with how they want their assets distributed and less in accord with the artificial requirements of estate planning.