Estate taxes are scheduled to phase out in 2010. The catch: They will return in 2011.
The tax legislation signed into law on June 7, 2001, could fundamentally change the way wealth passes from one generation to another. Then again, it may not change anything at all. What happened to tax simplification?
Much of the confusion derives from the fact that the new law repeals the estate tax, also called the "death tax," in 2010, but then brings it back from the grave in 2011! All of the tax cuts that became law will expire on December 31, 2010, unless they are renewed by Congress. No one expects that to happen, but uncertainty abounds as to just what Congress will do. In the meantime, smart financial managers must still make plans for the inevitable.
Until now, a coordinated system of gift and estate taxes imposed a tax with a marginal rate of 18 to 55 percent on the value of wealth transfers, whether the transfers took place during a person's lifetime (gift tax) or at death (estate tax). In addition, a generation-skipping transfer tax (GST) with a flat rate of 55 percent was imposed on cumulative transfers of more than $1 million to "skip persons," such as grandchildren, during the donor's lifetime. The present system of estate and gift taxes applies only to transfers in excess of an "applicable exclusion amount." Prior to passage of the bill, the exclusion amount was $675,000 for 2001, $700,00 for 2002 and 2003, $850,000 for 2004, $950,000 for 2005, and $1 million for 2006 and succeeding years. Estates with a value below the exclusion amount would owe no taxes.
This unified system meant that people could dispose of a total of up to $675,000 (in 2001) in the form of taxable gifts during their lifetimes and bequests at death without having their estates subject to the tax. In addition, an annual $10,000-per-recipient gift tax exclusion ($20,000 for joint gifts) was allowed for additional distributions of wealth without incurring any federal gift taxes. The old law also contained a 100 percent marital exclusion for transfers of wealth (gift or estate) between husband and wife.
Under the new rules, the estate tax and GST are to be phased out and eventually repealed, and the gift tax rules are to change.
First, the exclusion amount for estate taxes goes up over the next eight years. The exclusion jumps to $1 million in 2002, $1.5 million in 2004, $2 million in 2006, and $3.5 million in 2009. Meanwhile, the top tax rate for an estate goes down. The highest estate tax decreases to 50 percent in 2002, 49 percent in 2003, 48 percent in 2004, 47 percent in 2005, 46 percent in 2006, and 45 percent in 2007. It will then stay at 45 percent until 2010, when the tax is repealed.
Also, the link between the gift tax and the estate tax is severed. The lifetime exclusion for the gift tax increases to $1 million in 2002 and remains at that level. The annual $10,000 gift tax exclusion remains. The gift tax rates will decline in step with the estate tax rates, but when the estate and GST taxes are repealed in 2010, the maximum gift tax will be 35 percent – the top individual income tax rate.
The bottom line is that the tax law will change every year during the next decade. Along the way, many estate plans will need to be re-examined and rewritten, so see your financial planner or attorney right away and each year hereafter to make sure your documents are up to date and your assets are properly titled.
In terms of timing, if you're worried that the estate tax is never going away, or if you have a realistic fear that you might die before 2010, make sure you have enough cash in your estate to cover the tax. Otherwise, you should buy enough life insurance to cover the bill. Just make sure the life insurance is placed in a trust so the proceeds don't get taxed as part of the estate.
Milton Zall is a freelance writer based in Silver Spring, Maryland, who specializes in tax, investment, and human-resource issues.
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