Reviewing the Tax Relief Act of 2001 – Part 2

May 3, 2004

As we have noted in the previous newsletter, under the 2001 Tax Act (that President Bush has now signed into law), the amount exempt from estate taxes and the rate of tax on larger sums are slowly reduced beginning next year until 2010. At that time the estate tax (but not the gift tax) is repealed for one year. The new law then “sunsets”, meaning the law existing prior to the 2001 Act will be reinstated effective January 1, 2011. Thus, (a) in 2009 only estates in excess of $3.5 million will be subject to estate tax, at a top federal rate of 45%; (b) in 2010 there will be no estate tax: and (c) in 2011 we revert to estate tax on estates exceeding $1 million, at a top rate of 55%.

According to an article in The New York Times (June 14, 2001), these: roller-coaster changes can turn an estate plan drafted under the old law to eliminate estate taxes into a financial disaster. …Six prominent estate tax lawyers agreed in interviews [June 13th] that the repeal would probably not take place, but they all said individuals must have wills that take into account a range of possibilities, including all of the changes planned over the next 10 years, the possibility of permanent repeal and the prospect that repeal will never take place. …Those who…have a will and estate plan drafted under the old laws need to …have it reviewed and in many cases rewritten. …Without revisions, these experts said yesterday, widows may be left with far less than they expected, children and grandchildren may be stuck with huge tax bills that could have been avoided and litigation over who receives tax-favored assets may erupt, even in families whose members have worked together to build and preserve their wealth.

The above-quoted article may be somewhat alarmist, particularly in light of some interesting statistics the same newspaper published in a different article on April 8th this year: while 17% of Americans in a recent Gallup survey think they will owe estate taxes, only a much smaller perentage in fact do. “And nearly half the estate tax is paid by the 3000 or so people who each year leave taxable estates of moer than $5 million.” While The New York Times doesn’t specifically say so, the negative implication of this latter statistic is that somewhat more than half the estate tax is paid by people who leave less than $5 million (though we don’t have statistics to verify that inference).

We believe that clients are advised to continue to make “annual exclusion” gifts and take other steps to reduce estate tax where there is risk that they may die before repeal with an estate larger than $1 million. We also agree with the experts quoted by The Times above that it is sensible for clients to have their wills and other estate planning documents reviewed. Many clients may benefit from having their “optimum marital deduction” will updated to avoid the anomaly of having all or most of their estate diverted to the “Bypass” trust (a/k/a “Credit Shelter” trust). Further, since the gift tax exemption increases to $1 million per person in 2002, leveraged gifts via GRATs and Family Limited Partnerships will take on added importance in the “reform” period.