Understanding Estate and Gift Tax
During the 2000 campaign, Governor George W. Bush promised to slay the "death tax", if elected President. Making good on that promise just six months into his term, President Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA 2001) which repeals the estate tax in 2010, and in the meantime the amount which passes free of the estate tax is gradually increased. This death warrant for the estate tax may be rather illusory given the proven resiliency of the death tax. Because of budget restraints, the law provides for only a one year repeal with the estate tax return returning in 2011 with a $1 million exemption.
Currently the lifetime Exemption Amount for Gift Tax is $1 million and the Exemption for Estate Tax is $2 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 Unlike the death tax, however, the gift tax is not repealed in 2010, but merely adopts the top individual income tax rates in effect at that time under EGTRRA 2001. Additionally, EGTRRA 2001 greatly simplifies the Generation Skipping Transfer Tax (GSTT), increasing its Exemption Amount in lockstep with the death tax. Like the death tax, the GSTT is repealed effective 2010.
After enactment of EGTRRA in 2001, there were attempts in the Republican Congress to make the repeals permanent or, alternatively, to provide a $5 million per person exemption. The exemption is currently $2 million per person, and it will increase to $3.5 million in 2009. Nothing has been done since the Democrats recaptured the Congress in 2007, and no one knows with certainty what the estate and gift tax laws will be after 2009. Few believe that the tax will actually be repealed, and most hope that the exclusion after 2009 will be at least $3.5 million.
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.
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 It was repealed in 1802.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 It was repealed in 1870.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 It was repealed in 1902.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 increased to $1 million in 2002, and it went to $2 million in 2007. Concurrently, the top death tax rates will be reduced with the repeal of rates in excess of 50 percent (also repealed is the five percent surtax which phases out the benefit of the graduated rates for estates over $10 million). From 2003 until 2009, the Exemption Amount continues to increase to a high of $3.5 million in 2009 until the death tax is repealed effective 2010.
Sunrise, Sunset
Like a werewolf felled by a common lead bullet instead of a silver bullet, the death tax is not really dead after 2010. In fact, to ensure compliance with the Congressional Budget Act of 1974, all provisions of EGTRRA 2001 sunset for tax years beginning after December 31, 2010.* Accordingly, to borrow from Mark Twain, the rumors of the death of the death tax are greatly exaggerated.
Not only does EGTRRA 2001 sunset in 2010, but also its provisions are subject to change before then due to shifting political winds. Before the repeal in 2001, Americans will vote in another Presidential and congressional election. In addition to shifting political winds, shifting demographics may preserve the death tax well into the future. Consider this: The leading edge of the baby boom generation has begun reaching retirement. They will be retiring and lining up for the Social Security and Medicare programs in record numbers. With the budgeted cost of death tax repeal forecasted to be $50 billion in 2011, it may seem more palatable for politicians to once again tax the dead (i.e., non voters) to provide for the living (i.e. voters).
In addition to the sunset provision, shifting political winds and shifting demographics, throw in the uncertainties of the global and domestic economies, along with the historical potential for military conflicts, and the only thing certain about the death of the death tax is its uncertainty.
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.
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 EGTRRA 2001 tax law changes extend well beyond the scope of this brief and limited overview. As with any major tax law changes, it may be prudent to consult with legal counsel to evaluate the impact of the new death tax on your plans.
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