On May 26, 2001 the United State Congress passed a ten year tax cut bill that repeals the Federal Estate Tax beginning in 2010. President Bush signed this bill into law on June 7, 2001. This law represents the largest tax cut in the past two decades; but please bear in mind that the transfer tax system, (a combination of the Federal Estate Tax, Gift Tax and the Generation Skipping Tax) generates $175 billion dollars per year to the United States government. The transfer tax system cannot be eliminated without a replacement and history has proven that the last two estate tax bills never lived long enough to see their full incorporation into our system of taxation.
The following represents some of the highlights of the 441 changes in the new law :
I – INCOME TAX
- The present 28% income tax rate will become 27%; the present 31% rate will become 30.5%; the present 36% rate will become 35.5% and the present 39.6% income tax rate will become 38.6% .
II – ESTATE TAX
- The following table demonstrates the changes in the “Exemption Amount” and the highest tax rate in the Federal Estate and Generation Skipping Tax under the new Tax Act:
Year Exemption Amount Tax Rate 2002 $1,000,000 50% 2003 $1,000,000 49% 2004 $1,500,000 48% 2005 $1,500,000 47% 2006 $2,000,000 46% 2007 $2,000,000 45% 2008 $2,000,000 45% 2009 $3,500,000 45% 2010 N/A Estate Tax Repealed —
Gift Tax remains
2011 ESTATE TAX REINSTATED TO 2001 AND 2002 STATUS
WITH $1,000,000 EXEMPTION AND 55% MAXIMIM TAX RATE
- January 1, 2010 Estate and Generation Skipping Taxes are repealed.
- January 1, 2010 Gift Tax Rate will be equivalent to the individual income tax rate.
- Transfers of property to a Trust wholly owned by the grantor or grantor’s spouse are excluded from gift taxation.
- After repeal of Estate and Generation Skipping Transfer Tax the present laws providing for stepped up basis for property acquired from a decedent are repealed. The new law provides a “carry over basis” effective January 1, 2010; under this provision the tax basis for assets held at death will no longer be “stepped-up” to fair market value at that time. Two exceptions to this “carry over basis” will apply (a) a three million dollar exemption for assets passing to a surviving spouse; and (b) a 1.3 million dollar exemption for transfers to anyone else.
- The effect of the creation of “carry over” basis would create significant taxation by heirs which can be eliminated by the effective creation and implementation of a Life Insurance Trust.
III – THE SUNSET PROVISION
All of the above provisions regarding the new Estate Tax Law are temporary under the Congressional Budget Act of 1974. Therefore, all of the above provisions of the new legislation will expire December 31, 2010 and on January 1, 2011, the maximum Estate Tax rate for 2001 of 55% will be reinstated and the 2002 “Exemption Amount” of $1,000,000 will be reinstated .
IV – THE MARRIAGE PENALTY; IRA’S, 401(k)’s – Income Tax Deferred Plans
- In the year 2005 the new law provides a gradual increase in the standard deduction for couples. The marriage deduction increases to 174%; thereafter, increases to 184% in 2006; thereafter, increases to 187% in 2007; thereafter, increases to 190% in 2008; and 200% of a single deduction in 2009
- Increases in the contribution amount to Individual Retirement Accounts will change as follows: (a) $3,000 commencing 2002 through 2004, (b) $4,000 in the calendar years 2005 through 2007 and (c) $5,000 in the calendar year 2008 with increases for inflation thereafter in five hundred dollar increments. The $5,000 limit in 2008 will be worth only $2,014 in 1981 dollars.
- Contributions to (401(k), 403(b) or other tax deferred retirement plans) will be increased from the present $10,500 limit this year to (a) $11,000 in 2002, (b) $12,000 in 2003, (c) $13,000 in 2004, (d) $14,000 in 2005, (e) $15,000 in 2006, thereafter indexed for inflation. Daniel Halpern, of Harvard University has stated that the higher savings limits for retirement plans will represent 50 billion reduction in government tax revenue over the next decade.
V – REVOCABLE TRUSTS AND ESTATES
- Incorporation of the income tax exclusion for capital gains realized on the sale of a personal residence – $250,000 for a single individual, $500,000 for a married couple. This income tax exclusion was not previously available after the death of a owner of a residence.
- Individual State Inheritance or Estate Taxation has historically been of little significance in Federal Estate Planning and Taxation due to the systems created in the various states which permits a credit against taxation which can result in no individual state tax liability.Commencing in 2002 the state credit is decreased by 25% and is entirely eliminated in 2005; this will in all probability create new legislation in individual states generating state inheritance or estate taxation to compensate for the loss created by the federal government.