MEMORANDUM
TO: Clients and Friends of the Law Offices of Craig Berman, LLC
As you probably know, on June 7, 2001, President Bush signed new tax legislation which provides major changes in the income tax code, estate tax code, gift tax code and generation-skipping transfer tax code. The purpose of this memorandum is to summarize and highlight the significant changes in the estate tax code, gift tax code and generation- skipping transfer tax code.
Present Law
Generally. A gift tax is imposed on lifetime transfers and an estate tax is imposed on transfers at death. The unified estate and gift tax rates begin at 18% on the first $10,000 of cumulative taxable transfers and reach 55% on cumulative taxable transfers over $3,000,000.
Gift Tax annual exclusions. Donors of lifetime gifts are provided an annual exclusion of $10,000, or $20,000 for split gifts between a donor and spouse.
Unified Credit. The unified credit amount effectively exempts from tax, transfers totaling $675,000 in 2001, $700,000 in 2002 and 2003, $850,000 in 2004, $950,000 in 2005 and $1,000,000 in 2006.
Transfers to a surviving spouse. A 100% deduction from tax is generally permitted for the value of property transferred between spouses.
Basis of property received either by lifetime gift or upon death.Generally, taxable gains or losses, if any, on the disposition of property is measured by the taxpayer’s amount realized (i.e. gross proceeds received) on the disposition, less the taxpayer’s basis in such property. Basis generally represents a taxpayer’s cost investment in property with certain adjustments.
Property received by a donee (i.e. person receiving the property) from a lifetime gift takes the same basis as the donor’s (i.e. person transferring the property) basis. Property received by beneficiaries of a decedent’s estate generally take a “stepped up” basis that is equal to the fair market value of the property as of the date of death. This increased (or decreased) basis eliminates the recognition of gain on any appreciation of the property that occurred during the decedent’s life (or recognition of loss).
Family-owned business deduction. An estate may deduct up to $675,000 in value of a qualified-family owned business interest. Generally, a qualified family-owned business interest is any interest in a trade or business if the decedent’s family owns at least 50% of the trade or business. To qualify for the deduction, the decedent (or a member of the decedent’s family) must have owned and materially participated in the trade or business for at least 5 of the 8 years preceding the decedent’s date of death. Additionally, at least one qualified heir (or member of the qualified heir’s family) is required to materially participate in the trade or business for at least 10 years following the decedent’s death.
Generation-Skipping Transfer Tax (GST). Generally, a generation-skipping transfer tax is imposed on transfers, either directly or through a trust or similar arrangement, to a “skip person” (i.e. a beneficiary that is two generations below that of the transferor). The generation skipping transfer tax is imposed at a flat rate of 55% (i.e. the top estate and gift tax rate) on cumulative generation-skipping transfers in excess of $1,000,000 (indexed for inflation, in 2001 the exemption is $1,060,000).
New Tax
Legislation
“Phaseout and repeal” of estate tax and generation-skipping transfer tax.
The following chart depicts the estate tax, gift tax and GST rates, and unified credit effective exemption amounts for estate tax and GST:
Year Exemption Amount Highest 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 NA – Tax Repealed Estate Tax Repealed
GST Tax Repealed
Gift Tax Rate = Individual
Income Tax Rate
**2011 New
Tax Legislation expires (unless extended or modified by Congress) due to
failing to satisfy technical Senate budget requirements. Therefore, the
estate tax and gift tax rate and unified credit effective exemption is equal to
what they would have been under “Present Law”, or 55% and the $1,000,000
exemption.
Gift Tax continues. As the chart depicts above, the gift tax is not repealed. The gift tax rates are as depicted in the chart. The gift tax maximum exclusion is capped at $1,000,000 for 2002 and all subsequent years.
Basis of property acquired from decedent. In 2010, the rules providing for a “stepped up” basis equal to the fair market value of the property received as of date of death are repealed. Instead, beneficiaries will receive a basis equal to the lesser of the basis of the property in the hands of the decedent, or the fair market value of the property on the date of death. Therefore, the transfer is treated as if the property were received as a lifetime gift and eliminates the benefit of the nonrecognition of gain on any appreciation of the property that occurred during the decedent’s life.
Basis increase, generally. In 2010, an executor of the estate of the decedent may increase or “step up” the basis of assets inherited by the beneficiaries up to a total of $1,300,000. Additionally, property inherited by a surviving spouse can be increased by an additional $3,000,000, or a total of $4,300,000. The asset to be increased is determined on an asset-by-asset approach, at the election of the executor.
Family-owned business deduction. Repealed for decedent’s dying after December 31, 2003.
Planning and Conclusion
There have also been significant changes in the income tax code, which is beyond the scope of this Memorandum. However, a very important income tax change, which also relates to estate tax and gift tax planning, concerns Qualified State Tuition Programs created under Section 529. Contributions within the “Section 529” plans will in effect, grow tax-free, if distributions from the plans will be used to pay for qualified education expenses after December 31, 2001. Parents, grandparents or others, could contribute to a plan for the benefit of a child or grandchild beneficiary, which will be used to pay for qualified higher education expenses (tuition, room and board, books, etc.) at any eligible two or four year college, university, graduate school or post secondary vocational training program. Parents or grandparents can contribute up to $10,000 per year per beneficiary ($20,000 if spouse files a joint income tax return) without exceeding the federal annual exclusion, or, $50,000 per beneficiary can be contributed to cover a five year period ($100,000 if spouse files a joint income tax return) gift tax free, so long as no further gifts are made in the five year period. As you can see, the plans offer significant income tax benefits, while offering significant estate tax and gift tax planning opportunities.
Finally, the New Tax Legislation leaves great uncertainty as to whether the new rules will continue after December 31, 2010, because the New Tax Legislation expires in 2011. Furthermore, political action regarding the legislation provides additional uncertainty depending on which political party controls the houses of Congress or the presidency. Remember, in 1994, a Democratic controlled House of Representatives and Presidency pushed the passage of legislation that would have decreased the unified credit effective exemption to $200,000, rather than raising it to the levels under “Present Law” when the Republicans gained control of the House of Representatives. Therefore, the future political climate may lead to significant modification, extension or even termination of the New Tax Legislation. The bottom line is that now, more than ever, we will have to carefully review changes in the tax law and their effects on our estate planning. If you wish to further discuss the contents of this Memorandum, feel free to call me anytime.