 Update
on the Death Tax Elimination
June 2001 What
is it?
The
Death Tax, also known as the federal estate tax, has
been part of the American Tax system on an 'on-and-off'
basis since the Civil War. Last year, both the House
and Senate passed measures that purported to repeal
this tax. President Clinton vetoed the bill. In the
2000 election, Republicans campaigned for estate tax
repeal. On Saturday, May 26, 2001, both houses of
Congress passed The Economic Growth and Tax Relief
Act of 2001. This law addresses a number of taxes.
President Bush signed this bill early in June. Theoretically,
it reduces income tax rates, expands the child credit,
repeals the marriage penalty, expands education incentives,
reduces gifts taxes, reduces and then repeals the
estate tax and expands retirement plans.
Only
in Washington does the word "repeal" mean it goes
away only temporarily and then returns one year later.
Here is the final, and most significant, provision
of the law (Title IX). It is labeled "Sunset of Provisions
of Act".
In
General. - All provisions of, and amendments made
by, this Act shall not apply (1) to taxable, plan,
or limitation years beginning after December 31, 2010,
or (2) in the case of title V [note: this is the part
of the bill that purports to provide estate tax relief],
to the estates of decedents dying, gifts made, or
generation skipping transfers, after December 31,
2010.
Superficially,
this Act appears to phase out the Federal estate and
generation-skipping taxes progressively until they
are fully eliminated in 2010. It also proposes to
replace the unified credit with "unified exemption"
for gifts made after December 31, 2001. However, careful
tax planners note that what the "large print giveth,
the small print taketh away." A Federal budget restriction
prevents the current Senate from committing future
Congresses to increased spending or tax cuts that
extend beyond the period covered by the current budget,
which is, in this case, 10 years. This is also known
in the Senate as the Byrd Rule named for Robert Byrd
of West Virginia. This rule, requires a "super-majority"
of 60 votes in the Senate to overcome. In order to
avoid the super-majority requirement (which they know
they could not obtain), Republicans included a sunset
provision in this legislation. In other words, they
sacrificed actual repeal to get their bill passed.
The
Economic Growth and Tax Relief Reconciliation Act
of 2001 Proposed Estate, and Generation-Skipping Tax
Phase-Out.
Rate
Reductions and Increased In Exemptions:
Total
repeal will not take effect until January 1, 2010.
Only at that time would all federal estate and generation
skipping transfer taxes be repealed and then only
for a one-year period. Between January 1, 2002 and
December 31, 2010, the bill reduces federal estate
and gift tax rates as follows:
Schedule
of Changes
|
YEAR
|
FEDERAL
ESTATE TAX RATE
|
DEATH
TIME FEDERAL ESTATE & GST* EXEMPTION
|
|
2002
|
50%
|
$1,000,000
|
|
2003
|
49%
|
1,000,000
|
|
2004
|
48%
|
1,500,000
|
|
2005
|
47%
|
1,500,000
|
|
2006
|
46%
|
2,000,000
|
|
2007
|
45%
|
2,000,000
|
|
2008
|
45%
|
2,000,000
|
|
2009
|
45%
|
3,500,000
|
|
2010
|
0%
|
Estate
Tax & GST eliminated
|
|
2011(and
thereafter)
|
55%
|
1,000,000
|
*Generation
Skipping Tax
Loss
of Basis Step-up:
Significantly,
this Act generally replaces the "stepped-up basis"
rule with a "carry-over basis" rule (i.e., the basis
of assets received from a descendent generally will
be carried over from the basis of the decedent). However,
when the new law is implemented, it would also provide
for a step up in basis for [a] $1.3 million of transfers
from decedants to beneficiaries, and [b] $3 million
of transfers from decedents to surviving spouses.
It is also important to note that in many States,
State Death Taxes which are currently treated as a
credit against the Federal Tax, would also continue
and would now be paid outright. Thus, even when and
if the estate tax is repealed in 2011, a tax will
be imposed when transferred property is converted
by heirs to cash. However, it will be at a capital
gains rate.
No
Repeal of Gift Taxes:
It
is also worth noting that this Act does NOT repeal
the gift tax. Key tax experts see this as an acknowledgment
that the tax will probably be re-imposed in years
after 2010 or sooner. If the gift tax were repealed,
even for a year, it would allow the wealthy to gift
substantial portions of their estate in 2010. Once
gifted, they would then avoid any tax that would be
re-imposed because of the sunset provision. This Act
prevents them from doing that. As much as wealthy
people hate the estate tax, there are few that would
time their death to coincide with the repeal date
of 2010. If the goal of lawmakers was to forever repeal
estate tax, they could accomplish this by repealing
gift taxes. It is postulated that had gift taxes actually
been repealed as part of this bill, 2010 would have
seen massive lifetime transfers. Also note that the
increasing exclusion only applies to death transfers.
The gift exclusion remains at $1,000,000.
What
is the probability of future reductions?
Congressional
Democrats characterize the current law as "regressive"
and a tax break for the extremely wealthy. They point
to benefits such as Medicare prescription drug coverage
as worthier programs ranking higher on their priority
list. Meanwhile, Republicans characterize this law
as relief from an excessive, unfair tax that destroys
family farms and business.
In
order for any promise of true lasting estate tax reduction
relief to come in a future bill, the following must
occur:
The
Republicans must regain control of both Houses of
Congress to pass future budgets that extend the relief
beyond 10 years.
Alternately,
if the Republicans can maintain their margin in the
House and somehow obtain a majority of 60 in Senate,
they could change Senate rules and enact changes that
would extend beyond 2010. The current Democratic control
of the Senate and the finance committee makes it unlikely
that any future bill would be reported out.
The
economy must remain strong enough during the next
10 years so continued projected surpluses make this
relief possible.
If
the economy falters, the large surpluses that make
this cut possible could quickly evaporate. The proposed
reductions in tax revenue escalate exponentially in
future years. This phase-out produces almost no reduction
in tax revenue in the near term, but very large amounts
in future years. Unfortunately this is the same time
period when Social Security and Medicare will be under-funded.
This may put future Congresses in a position where
it may be difficult to refrain from delaying phase-ins
or re-imposing the tax.
Observations and Planning Issues
The
only constant is change: The current version of the
estate tax was created in 1910 and changed 12 times
before 1976. It has changed 11 times since 1976, including
three changes in the 1990's.
Congress
tried to eliminate the capital gains step-up once
before in 1976. Difficulties in administering capital
gains basis caused Congress to repeal this attempt.
Without this alternate source of revenue, the proposed
bills have much larger fiscal impact and will have
to compete for revenue dollars with other promised
cuts and proposals. This also assumes that future
Congresses would not increase the capital gains rate
substantially.
The
repeal is not scheduled to take effect for 10 years
and then only for one year! Even if passed, the phase-out
will need to run the gauntlet of five Congressional
election cycles and two more Presidential Administrations
between now and 2010, any of which could modify or
completely reverse the repeal.
While
the current death tax is perhaps an unfair tax, it
is being imposed on less than 1% of Americans. This
large block of potential tax revenue is a tempting
target for current or future populist politicians
to point to as a "giveaway for the rich". As competing
priorities take shape in future budget debates, this
small group may have difficulty maintaining its place
in line for promised benefits.
What Should Clients Do?
Planning
for affluent clients always involves uncertainty.
While it is relatively easy to establish what kind
of tax liability may be due under current laws, consider
the impact on estate planning for these clients, assuming
the proposal's most favorable outcome.
First,
it is important to remember that the proposed tax
is intended to be phased out, so death taxes are due
for the next 10 years. Second, many affluent clients
have estates that are comprised of closely held business
stock, appreciated real estate, and/or qualified plan
assets. Under the proposed legislation, these assets
would now be subject to a capital gains tax, from
which they are currently exempt. Qualified plan assets
still are and will be subject to ordinary income tax
rates as income with respect to the decedent. Also,
State Death Taxes would have to be paid outright.
Currently, they are treated as a credit on the Federal
Estate Tax return.
How
can you be sure you are leaving more to your heirs
and less to the IRS?
Each
person has different needs in developing a strategy
to effectively deal with the loss of wealth associated
with estate taxes. Some may be dealing with the problem
of having a large portion of their wealth in IRAs
and pension plans. Others may need to provide liquidity
to pay the estate taxes on illiquid assets.
The
most effective way to be sure you are leaving more
to your heirs and less to the IRS is to work with
a professional who will help you develop a strategy
taking into account not only estate tax at your death,
but also addressing income tax and cash flow issues
while you are alive.
|
