Understanding Estate and Gift Tax
In mid-2001, just six months into his term, President Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA 2001) which gradually increased the amount which passes free of the estate tax and repealed the estate tax in 2010. That gradual increase ended at the beginning of 2009 when the amount passing free of estate tax increased from $2 million to $3.5 million. For several years the consensus was that the repeal scheduled for 2010 would not happen. The were two reasons for this consensus. The repeal was to last for only one year with the estate tax re-imposed in 2011; there were failed attempts in the Republican Congress to make the repeals permanent or, alternatively, to provide a $5 million per person exemption . The Democratic party took control of Congress in 2007, effectively ending the Republican hopes for a permanent repeal.
Currently the lifetime Exemption Amount for Gift Tax is $1 million and the Exemption for Estate Tax is $3.5 million (reduced by any part of the $1 million gift tax exemption used during lifetime). The top gift tax rates are the same as the death tax rates. Unlike the death tax, however, the gift tax was never scheduled to be repealed. Additionally, EGTRRA 2001 greatly simplified the Generation Skipping Transfer Tax (GSTT), increasing its Exemption Amount in lockstep with the death tax. Like the death tax, the GSTT was to be repealed effective 2010.
The long-term picture is still unclear, although the repeal appears will not happen. The new Administration and the Democratic Congress seem to be in agreement that there will be a $3.5 million exemption in 2009 and 2011. What will happen in 2011 is uncertain, but there is discussion of allowing couples to combine their individual exemptions (which would simplify estate planning) and of indexing the exemption for inflation. Most observers believe there will be increasing need for tax revenue, so the $3.5 million exemption may not continue in the long term.
The death tax is nothing new. In fact, Americans have seen three variations of the death tax come and go. The current death tax, the target of EGTRRA 2001, is the fourth variation, and by the end of 2010 we will probably have the fifth variation.
The first death tax was enacted at the end of the eighteenth century to finance American naval expansion during tensions with France. It was repealed in 1802. The second death tax arose following the outbreak of the Civil War. It was repealed in 1870. The third death tax was implemented at the end of the nineteenth century to finance the Spanish American War. It was repealed in 1902. Shortly thereafter, in 1916, the current death tax was enacted to help finance America=s entry into World War I. This was to be the War to End All Wars. Uncharacteristically, that fourth version of the death tax was not repealed when the war ended and the doughboys returned from France.
In the years that followed, the death tax has helped the federal government underwrite Depression Era programs, subsequent foreign wars, the War on Poverty, the Space Program and the Cold War. Throughout the last century, the continued expansion of the size and scope of the federal government drove a corresponding need for additional tax revenues. Not surprisingly, every attempt to reform or repeal the death tax has provided fertile soil for economic class warfare.
Key Provisions of the Current Law
Fundamental to the death tax is the amount each taxpayer may exclude from the tax. Known as the Unified Credit Effective Exemption Amount (Exemption Amount), this amount was set at to $1 million in 2002, went to $2 million in 2007, and is now $3.5 million. The estate tax, like the income tax, was graduated, but now that the exemption has increased the first dollar over that amount is taxed at the maximum (now also the minimum) rate of 45%.
Winners & Losers
There are winners and losers in the game of tax politics. The real winners under EGTRRA 2001 are the taxpayers with otherwise taxable estates who are fortunate enough to die between January 1, 2010 and December 31, 2010. The biggest losers have been state governments. Many states had a death tax tied to the maximum state death tax credit permitted for calculating federal estate taxes. Under EGTRRA 2001, this credit amount was gradually reduced to zero in 2005. Consequently, under the old state laws there would be no tax. Some states have enacted alternate tax provisions to recapture lost revenue, and others have simply repealed the estate tax. The Virginia estate tax was repealed in July of 2007. Maryland and the District of Columbia have retained the $1 million, so the estate of someone dying in those jurisdictions who uses the full federal exemption of $3.5 million for a trust or transfer to heirs other than a spouse will have to pay a state death tax even though there would be no federal death tax.
Proper Planning
Until Congress and the President can repeal incapacity and death, there will be a need for proper Life & Estate Planning. Space does not permit a comprehensive review of the non tax reasons for planning. Nevertheless, only through proper planning can you maintain control over your wealth and independence in the event of your incapacity, appoint the back up parents for any minor children in the event they are orphaned, protect the inheritance for and from your heirs, provide financial support for loved ones with special mental or physical challenges, meet your competing support obligations if yours is a blended family, make specific distributions of your assets to specific persons and ensure the successful continuation of your family business.
Summary
The breadth and depth of the current estate and gift tax laws extend well beyond the scope of this brief and limited overview. Uncertainty remains about what the future law will, and it may be prudent to consult with legal counsel to evaluate the impact of the estate, gift and generation skipping transfer (GSTT) taxes on your plans.
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