The Economic Growth and Tax Relief Reconciliation
Act of 2001 (EGTRRA) made drastic changes as to how estates are taxed.
Specifically, over the next decade, the exemption amounts for the estate
and GST taxes will increase, while the highest tax rates will decrease,
as illustrated in Chart I.
See I.R.C. §§ 2001(c),
2502(a), 2010(c).
The GST exemption differs because it is pegged to
“cost-of-living” increases the Internal Revenue Service
(“IRS”) publishes in revenue procedures.
Then, in 2010 (for just one year), both the estate and GST taxes will
be repealed or eliminated. See I.R.C. §
2210(a). In 2011, as the law stands written, the entire law will
expire and the rates will go back to their 2001 levels. Another term
for this type of provision is “sunset,” as in the legislation
sunsets on December 31, 2010. Accordingly, the way the law stands today
the estates of individuals dying in the year 2010 will not be subject
to those taxes.
Unfortunately, for individuals dying after January 1, 2011, the estate
and GST exemption amounts and tax rates revert back to pre-2002 levels,
thereby creating a much higher tax liability for those estates. See
I.R.C. § 2001(c).
For individuals tempted to give away all their property during their
lifetime, the stagnant gift tax exemption does not support this proposition.
As shown in Chart I, the $1,000,000 gift tax exemption amount does not
change over the years, even after the estate and GST taxes are repealed
in 2010. See I.R.C. § 2505(a).
Another problem under EGTRRA involves capital gains tax, which applies
when property appreciates in value. Currently, when someone dies, all
property includable in his or her estate for estate tax purposes receives
a “step up” in basis to its value on the date of death (or
an alternate valuation date). See I.R.C.
§ 1014. So, when the heir sells the property near the time
of inheritance, the property is not subject to capital gains tax.
Example: Marcus
died last month at age 65. He had been a widower for 10 years. He was
survived by his four children, Alice, Tanya, Bob and Elliott, and his
younger sister, Kate. Marcus and his late wife bought their Bethesda
home in 1970 for $20,000, including the furnishings. Today, the home
and its contents are worth $475,000. Marcus’ will left the home
to his children to be split equally. Since the children live in other
states, they decide to sell the fully furnished home and to divide the
proceeds. Under I.R.C. §
1014, any appreciated property receives a “step-up”
in basis upon the death of the owner. As such, the Bethesda home and
the furnishings will now have a basis of $475,000 (its market value)
instead of the original $20,000. If the children sell the home for $475,000,
they will not be taxed on the $455,000 difference in the original purchase
price and sales price.
Under EGTRRA, the step up in basis will be eliminated when the estate
tax is eliminated (for deaths in 2010). See I.R.C. §§ 1014,
1022. Instead of an unlimited step up in basis, there will be a general
maximum step up of $1.3 million for the entire estate which can be allocated
among all of the decedent’s assets by the executor. See
I.R.C. § 1022. A surviving spouse would receive a $3 million
step up in basis. Anything over that amount, however, would receive
the decedent’s basis, also known as “carry-over” basis.
See I.R.C. § 1015. This
change could potentially burden the estate and its heirs with a high
estate tax liability. As with other instances of capital tax liability,
detailed records must be kept to document basis information.
Example: Marcus
dies in 2010. He is survived by his four children, Alice, Tanya, Bob
and Elliott, and his younger sister, Kate. Marcus and his late wife
bought their Bethesda home in 1970 for $20,000. At his death the home
and its contents are worth $1,475,000. His will left the home to his
children to split equally. Since the children live in other states,
they decide to sell the home and divide the proceeds. Under I.R.C.
§§ 1014,1022,
any appreciated property receives a “step up” in basis upon
the death of the owner, but only to $1,300,000. As such, the Bethesda
home and the contents will now have a basis of $1,300,000 instead of
the original $20,000. If the children sell the home and furnishings
for $1,475,000, they will pay capital gains tax on the $175,000 difference
in the maximum step-up basis and the sales price.
In addition to federal estate taxation, some states also impose their
own estate taxes. However, in order to reduce the dual burden, federal
law now provides for the sharing of revenue from the estate tax with
states via the state death tax credit. See I.R.C.
§ 2011.
States can receive substantial state revenue
through this credit. EGTRRA will eliminate the state death tax credit,
reducing it to zero in 2005. See I.R.C.
§ 2011. Rather than receive the money from the federal government
through the credit, states will get the differential in amounts directly
from the estates.
Congress may decide to pass future legislation that would either extend
the more favorable exemption amounts and rates or design some other
solution to this problem. Meanwhile, individuals who are preparing estate
plans face the added challenge of how to plan properly, given this uncertainty.
As shown by the coverage of the topics in this
chapter, the area of federal estate and gift taxation is in a constant
state of flux. As such, it is important for anyone working in this area
to keep abreast of any changes and incorporate them into estate planning.
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