Estate, Gift and Generation-skipping Transfer Taxes.

1. Estate and generation-skipping transfer taxes. The estate and generation-skipping transfer taxes are to be phased out over a nine year period. The phase out is accomplished through a combination of a reduction in tax rates and an increase in the applicable exclusion amount (also called the exemption amount). The following table shows the exemption amounts and highest estate tax rates for the years of the phase out. There is a sunset provision in the law that reinstates the provisions of previous law in 2011 unless Congress takes affirmative action to extend or make permanent the repeal of estate and generation-skipping transfer taxes.

Increase in exemption amounts, phase out in 2010, with sunset as of December 21, 2010.

2. Gift Tax. The gift tax is not phased out nor repealed. On January 1, 2002, the exemption amount for gift tax will increase to $1,000,000. This means you will be able to give away $1,000,000 during your lifetime without paying a gift tax. The exemption amount is in addition to the $10,000 for annual exclusion gifts. Lifetime gifts made with the gift tax exemption amount before repeal of the estate tax will reduce the available estate tax exemption amount as such gifts did under the old law. Beginning 2010, the top gift tax rate will be the same as the top individual income tax rate.

3. Need for Estate Tax Planning. The provisions of the new law do not eliminate the need for estate tax planning. Estate tax planning will still be required during the extended period of phase out unless you can be certain you will live to 2010. Also, the sunset provision will reinstate the estate and generation-skipping transfer tax in 2011 as those taxes were before 2002. That means we will go back to a maximum of $1,000,000 applicable exclusion amount for both estate and gift taxes and back to the higher tax rates. To avoid this result, the projected federal budget surpluses must materialize and Congress must take action to extend the new law or make it permanent.

4. Other Reasons for Estate Planning. If repeal of estate and generation-skipping transfer taxes is completed in 2010, there will still be many non-tax reasons for estate planning. Probate avoidance upon death and disability will remain extremely important reasons to use revocable trust estate planning. Family partnerships or limited liability companies will continue to provide valuable business continuation planning and asset protection for partners or members from creditors and divorce. They also permit the older generation to shift taxable income to a younger generation without giving up control of the property owned by the partnership or limited liability company. Protection of property passing to spendthrift or disabled spouses, children, and grandchildren will remain an important reason for trust planning. Marital trust planning will remain important in second or blended marriages to provide a life income to a second spouse and protect principal for children of the first marriage. Without a generation-skipping transfer tax, it will be much easier to create long term dynasty trusts for the benefit of grandchildren and future generations. Charitable remainder trusts will continue to provide significant income tax savings through income tax deductions and their ability to convert appreciated, low income property to higher income property without capital gain. Insurance trusts will remain valid to provide insurance to pay anticipated capital gains taxes or to provide a means of equalizing an estate between children who want to continue the family business and those who would rather liquidate it and receive their share.

The New Death Tax - Capital Gains Tax.

1. Elimination of Step Up in Basis. If repeal of the estate and generation-skipping transfer taxes is completed without change, a capital gains tax will be substituted for estate and generation-skipping transfer taxes. The new law eliminates the step up in tax basis for property acquired from a decedent. Under present law, the tax basis of a decedent's property is increased to its fair market value as of the date of the decedent's death. That means that when the property is later sold by the decedent's children or spouse, there is no capital gain tax.

2. Carry Over Basis at Death. Beginning in 2010 after the estate and generation-skipping transfer taxes are repealed, present law permitting a step up in basis for property acquired from a decedent will also be repealed. This means the heirs will receive the decedent's property with the same tax basis the decedent had in the property. If the heirs sell the property, they will have to pay federal and state capital gains taxes on the difference between the sale price and the decedent's tax basis. If the heirs are unable to determine the decedent's tax basis in the property, it will be assumed that the basis is zero. If the property acquired from a decedent had been depreciated, a sale by the heirs will also be subject to the recapture tax. To determine a decedent's basis in property, it will be very important to maintain accurate records of purchase prices, improvement costs, depreciation, stock splits, and reinvestment of stock dividends and capital gain distributions.

3. Limited Step Up Allowed. The new law will permit two limited tax basis step ups for a decedent's property. First, a decedent's estate may increase the basis of a decedent's property up to $1,300,000 regardless of who receives the property. Second, an additional increase in basis is permitted for up to $3,000,000 of property passing to a surviving spouse. By planning to use a combination of the two permitted basis increases, heirs of a decedent will be able to avoid capital gain or recapture taxes on a total of $4,300,000 of property received from a decedent. For purpose of these limited step ups in basis, property of a decedent may be owned by the decedent or by the decedent's revocable trust.

4. Capital Gain Estate Planning. Estate planning to fully use the permitted step ups in tax basis could be very similar to our present estate tax planning to use the applicable exclusion amount and estate tax marital deduction. To minimize the potential capital gains taxes of the heirs, we could use a trust that divides at death into a two share arrangement similar to the credit shelter and marital shares we use now for estate tax planning. The first share would be trust for the benefit of the surviving spouse and the children with terms similar to the credit shelter or family trust presently used for the applicable exclusion amount. This share would receive property with up to $1,300,000 of potential capital gain to use the first $1,300,000 of permitted step up in basis. The second share could be an outright distribution to the surviving spouse or a QTIP trust for the surviving spouse to use the additional $3,000,000 of basis step up permitted for property passing to a surviving spouse. Under the new law, the QTIP trust can be used to obtain the spouse's share of the step up in basis while limiting the spouse's rights to only the income from the trust property.