by
Bradley J. Frigon, Esq.

The "Economic Growth and Tax Relief Reconciliation Act of 2001 that was signed into law on June 7, 2001 made significant changes to the estate and gift tax laws. Under the new law, the individual estate tax exemption will increase beginning with the year 2002 as shown on the following chart:

Estate Tax Exemption Amount

Year of Death		Estate Tax Exemption
2001		$ 675,000
2002-2003		$1,000,000
2004-2005		$1,500,000
2006-2008		$2,000,000
2009		$3,500,000
2010		Estate Tax Repealed
2011		$1,000,000

In addition, the new law will reduce the maximum top estate tax rate from 55% to 50% beginning in 2002, and will gradually reduce the top estate tax rate to 45% in 2009. However, the repeal of the estate tax does not take effect until 2010, and the repeal may last for only one year. If, in 2011, Congress does nothing the estate tax will be reinstated and the estate tax exemption will return to $1 million. This automatic "sunset" provision was put in place in case the anticipated budget surpluses do not materialize on schedule or fall short of what was projected. In addition, there is nothing preventing a new administration or lawmakers from changing the law that was just passed.

Elimination of Step-Up Basis Rules

If the estate tax disappears in 2010, the current law that allows a step-up in basis on inherited property will also disappear. Under current law, property that passes to the decedent's heirs will receive a step-up basis equal to the fair market value of the asset at the date of your death. When your heirs sell the property they just inherited, capital gain tax will be owed only on the difference between the stepped-up value and the selling price. For example, if you own a quarter section of farm ground that you purchased for $100 per acre, and now the farm ground is worth $500 dollars per acre, you would pay capital gain tax on the difference between the selling price of $500 and your tax basis of $100. If you pass this farm ground to your children at your death, they would receive a new tax basis equal to the fair market value of the property at the time of your death. If the property was worth $500 per acre at your death, your children would receive a $500 dollar tax basis in the property. If your children later sell the property for $500 per acre, they would not pay any capital gains tax from the sale since their tax basis is equal to the selling price.

Under the new law, the step-up basis rule will be partially eliminated when the estate tax is repealed in 2010. In effect, Congress has substituted the estate tax for a capital gain tax. Under the new law, there will be a cap on the amount of property that will receive a step-up basis. How much property that will receive a step-up basis will depend on who inherits your property. You can pass property up to $1.3 million to heirs who are not spouses and receive a step-up basis for that property. Surviving spouses who receive property can add an additional $3 million for a total of $4.3 million of property that will receive a step-up tax basis.

In most situations, the payment of capital gains tax will always be lower than the payment of estate taxes. In addition, the new law will not make death a taxable event since the tax will not be generated until the heirs sell the property. However, you should remember that the rules relating to a step-up basis do not take effect until 2010 and will not continue unless Congress votes to extend the repeal by 2011. If these new provisions do become law, it will be vital to start keeping detailed records to determine the tax basis of your property. Now is the time for you to start keeping records to determine your tax basis for all the property you have already purchased or will purchase. You should not discard any records that determine your tax basis in your stocks or mutual funds, or any improvements you make to your house or farm property. If you do not keep these records, it will be impossible for your heirs to know what their tax basis is in the property they inherit from you.

Gift Tax Exemption.

The new law also changes the gift tax laws. Under the old rules, the estate and gift tax exemptions were the same. The new rules provide that everyone will have a $1,000,000 gift tax exclusion. While the estate tax exemption will increase to $3.5 million in 2009, the gift tax exemption will remain at $1 million after 2002. Although this will not affect most people, anyone who makes taxable gifts in excess of $1 million during their lifetime will be required to pay gift tax. Congress believed it was important to maintain the $1 million dollar gift tax exclusion to prevent very wealthy people from making lifetime transfers of income-producing property to heirs in lower income tax brackets to reduce income taxes.

What Should You Do?

What should you do about these constantly changing tax laws? Unless you plan to die in 2010 when the estate tax is repealed for one year, the best move is to plan your estate based upon the laws that are in effect now. It is premature to believe that the repeal of the estate tax will be permanent. If tax revenues do not meet projections, it will be likely some form of the estate tax will continue. In addition, we should not forget that most states impose some form of an estate tax. To my knowledge, none of the states are currently looking at repealing their estate tax systems.

Because of the complications imposed by this new law, it is critical to meet with your attorney to determine how the new tax law will impact your estate plan. If your current estate plan uses a formula to determine how much property will pass to your surviving spouse and how much will pass to other members of your family or to a trust, you should have your lawyer recalculate the numbers under the new rules.

Depending on the size of your estate, it may make more sense to revise your estate plan to allow the opportunity to make adjustments in your plan after the death of the first spouse. Keeping your plan flexible will be critical when facing the many uncertainties the new law created. However, you should always remember that the primary reason you plan your estate is to make sure that your assets pass to people you want and in the manner that you want.

Congress decided to make the system more complicated than it was and to impose uncertainty in the law. As such, you should ask your attorney to keep you informed about the new tax laws and they will impact your estate.