The Economic Growth and Tax Relief Reconciliation Act of 2001: estate, gift, and generation-skipping Transfer Tax Law changes: practitioners should review their clients' estate plans and consider modifying existing documents to provide additional flexibility in this uncertain time.

• Author: Pratt, David

Pursuant to the Economic Growth and Tax Relief Reconciliation Act of 2001 (the "act"), significant changes have been made to the estate, gift, and generation-skipping transfer (GST) tax provisions of the Internal Revenue Code of 1986, as amended (the "code"). Some of the most important provisions of the act from an estate planning perspective result in the gradual phase-out and eventual "temporary" repeal of the federal estate and generation-skipping transfer taxes. However, pursuant to the sunset provisions of the act, all changes made by the act become void on January 1, 2011, and the transfer tax laws that were in effect prior to the act was signed will be reinstated. Accordingly, the changes made by the act are only temporary. Complicating matters even further is the probability that Congress will make additional changes to the transfer tax provisions of the code over the next nine years.

As a result of the changes made and uncertainty caused by the act, estate planning will become complicated for many individuals. Estate planning must encompass three different phases: 1) the increase in estate and GST tax exemptions and concomitant decrease in transfer tax rates; 2) the repeal of the estate and GST taxes; and 3) the reinstatement of the transfer tax laws as they existed prior to the act. This article reviews the pertinent provisions of the act from an estate planning prospective (1) and provides suggestions for practitioners to consider when reviewing and implementing their clients' estate plans.

Increase in Exemption Amounts for Estate, Gift and GST Taxes; Reduction of Estate, Gift and GST Tax Rates; Repeal of Estate and GST Taxes

Under the law prior to the enactment of the act, the applicable exclusion amount for estate tax purposes is $675,000. (2) The act increased the $675,000 applicable exclusion amount to $3.5 million over the next eight years. (3) In 2002 and 2003, the applicable exclusion amount will be $1 million; in 2004 and 2005, it will be $1.5 million; in 2006, it will be $2 million; and in 2009, it will be $3.5 million. (4) In 2010, the exclusion will no longer apply because the act repeals the estate tax on January 1, 2010. (5) However, there is a sunset provision in the act which reinstates the estate tax on January 1, 2011. (6) If the estate tax were reinstated at that time, the estate tax laws, as they existed before the act, would apply (which means that the applicable exclusion amount would be reinstated at $1 million (7)).

The GST tax exemption in 2001 was $1,060,000; (8) such exemption will be indexed for inflation in 2002 and 2003, and then increased until 2009 in accordance with the schedule discussed in the preceding paragraph relating to the increase in the applicable exclusion amount. (9) In 2010, the GST tax exemption will no longer apply because the act repeals the GST tax on January 1, 2010, subject to the sunset provision discussed above. (10) In addition, in 2002 through 2009, the GST tax rate for a given year will parallel the maximum estate tax rates discussed in the following paragraph. (11)

As the applicable exclusion amount for estate tax purposes and the GST tax exemption for GST tax purposes increase, the estate and GST tax rates are reduced under the act. Under the old law, the lowest estate tax rate was 18 percent; such rate was imposed upon the first $10,000 of cumulative taxable transfers. (12) The highest estate tax rate was 55 percent; such rate was imposed upon cumulative taxable transfers in excess of $3 million. (13) Furthermore, cumulative transfers between $10 million and $17,184,000 were subject to an additional five percent surtax; (14) estates in excess of $17,184,000 were subject to a flat 55 percent tax rate on all amounts above the applicable exclusion amount for the given year. (15) In addition, the GST tax was imposed at the maximum federal estate tax rate. (16) Pursuant to the act, in 2002, the five percent surtax and the rates in excess of 50 percent are repealed. (17) In addition, the maximum estate tax rates will be reduced over the next eight years; such maximum rates are as follows: 49 percent in 2003, 48 percent in 2004, 47 percent in 2005, 46 percent in 2006, and 45 percent in 2007, 2008, and 2009. (18) Again, pursuant to the sunset provision discussed above, in 2011, the highest estate and GST tax rates would be reinstated at 55 percent, and the five percent surtax would return.

The act does not repeal the federal gift tax. Specifically, under the law prior to the enactment of the act, the current gift tax exemption is equivalent to the current applicable exclusion amount for estate tax purposes ($675,000). (19) For transfers subject to the federal gift tax occurring in 2002 and thereafter, the gift tax exemption will be $1 million. (20) Moreover, the maximum gift tax rates will decrease beginning in 2003; such rates are identical to the estate tax rate reductions discussed above. (21) In 2010, when the estate tax is repealed, the gift tax rate will be equal to the highest income tax rate, which is scheduled to be 35 percent. (22)

Replacement of State Death Tax Credit with Federal Estate Tax Deduction

Prior to the act, a credit was allowed against the federal estate tax for any estate, inheritance, legacy or succession taxes (hereinafter referred to as "death taxes") actually paid to any state or the District of Columbia with respect to any property included in a decedent's gross estate. (23) The maximum allowable credit for state death taxes was determined under a graduated rate table; the top rate was 16 percent. (24) Pursuant to the act, the state death tax credit is reduced by the following percentages: 25 percent in 2002, 50 percent in 2003, and 75 percent in 2004. (25) In 2005, the state death tax credit is repealed and a new deduction for death taxes actually paid is effectuated. (26) The state death taxes must have been paid and claimed before the later of: 1) four years after the filing of the federal estate tax return (Form 706); and 2)(a) 60 days after a decision of the U.S. Tax Court determining the estate tax liability becomes final; (b) the expiration of the period of extension to pay estate taxes over time under [section] 6166 of the code; or (c) the expiration of the period of limitations in which to file a claim for refund or 60 days after a decision of a court in which such refund suit has become final. (27)

Transition to Modified Carry-Over Basis for Property Received at Death

Under the old law, property passing from a decedent's estate generally takes a "stepped-up" basis, which means that the basis of property passing from a decedent's estate to a transferee is generally the fair market value of the property on the date of the decedent's death (or, the fair market value on the alternate valuation date, if elected, which is the earlier of six months after the decedent's death or the date the property is sold or distributed). (28) When a donor makes a...