July 2001

ESTATE PLANNING IN LIGHT OF THE TAX RELIEF ACT OF 2001

The tax legislation recently passed by Congress made wide-ranging modifications to the tax rules that apply to individual taxpayers, ranging from reductions in the tax rates to increased child tax credits to more generous IRA and pension limits. Also affected by the new legislation is the area of estate and gift tax.

You may have heard that the estate tax has been repealed, and wondered how that will affect your estate planning or whether there is even a need for estate planning any longer.

In fact, the new law fully repeals the estate tax (aka, the death tax) for just one year, 2010. While the amount that is subject to tax will decrease due to a gradual drop in rates and increase in exemption, the estate tax is fully gone only in 2010 under the new law. After that, depending on the state of the federal budget or the political climate, the new law would allow the current estate tax rules, rates and exemptions to be reinstated in 2011, depending on what Congress decides to do at that time.

In other words, the estate tax lives on, albeit with a slowly rising exemption and a slight drop in rates, through 2009, until 2010. Then it is repealed, but repeal is assured only for that year. And because it was necessary to come within budget limitations, the estate tax relief scheduled for the interim years (2001-2009) is much more modest than was originally discussed.

Phase-out Schedule
The phase out of the estate tax will follow a slow timetable: In 2002, the top estate tax rate will be reduced to 50%. The exemption will be $1 million. The rate will decrease by 1% each year through 2007, then it stays at 45% until 2010, when it is eliminated. The exemption, meanwhile, increases to $1.5 million in 2004; to $2 million in 2006, and to $3.5 million in 2009. The generation-skipping transfer tax will be tied to the highest estate tax rate throughout the ten-year phase-out period.

Modified Carryover Basis
While it decreases the actual amount of tax on estates themselves, the new law raises the possible income tax on inherited property when it is sold by your heirs. Once estate taxes are fully repealed in 2010, a modified carryover basis rule immediately goes into effect. Under current law, the basis of assets received from a decedent is "stepped up" to their fair market value on the date of the decedent's death. Under the new law, however, basis will be the same as it was in the hands of the decedent. This means that when your heirs dispose of the property they have inherited, they will pay tax on the difference between the sale price and the basis you had in the property, often the price you paid for it, adjusted for depreciation you took or improvements you made. Detail records must be kept so that your heirs have support of your basis.

Some property may escape this treatment, however. Two exceptions may be utilized to save many estates: a bump-up of $1.3 million will be allowed to the basis of certain assets, and an additional $3 million to the basis of assets transferred to your surviving spouse. Not all property will be eligible for this increase, however, so careful planning will be required to ensure that your estate is able to take advantage of these special provisions.

Partial Gift Tax Remains
Individual taxpayers will also continue to be subject to a modified gift tax. Starting in 2010, gifts in excess of a lifetime $1 million exemption would be subject to a gift tax equal to the top individual income tax rate at that time.

Other Tax Impacts
Given the slow timetable over which estate tax is to be phased out, and the uncertainty of its permanent repeal, the need for estate planning is as great as ever. In addition, changes to the income tax and the rules regarding IRAs and retirement plans make those items important considerations in estate planning as well. With the reduction and repeal of estate tax on the horizon, it becomes more important, and more valuable, to defer as much tax as possible on assets that you intend to leave to your heirs.

The new and improved retirement plan rules can also be useful tools in that regard. As you are allowed to defer more dollars on a tax-deferred basis and the relaxed distribution rules require you to take less from your plans during your lifetime, the opportunities have never been greater to put away tax-deferred amounts. Careful estate planning now can ensure that you preserve as much as is possible, for the benefit of your heirs, and yourself.

We would be pleased to assist you in separating the opportunities from the pitfalls in planning your estate in light of Congress's latest changes to the tax law. In order to maximize the benefits of this new law, your strategic planning should begin as soon as possible.

Veres & Company
Certified Public Accountants
Freedom Square Office Park
4401 Rockside Road, Suite 406
Independence, Ohio 44131
(216) 524-8422
Fax (216) 524-2624
e-mail: staff@veres.com