Estate Planning in Light of Tax Relief Act of 2001

September 2001

The tax legislation recently passed by Congress (2001 Act) made wide-ranging modifications to the tax rules that apply to individual taxpayers, including changes to the gift and estate tax laws. You may have heard that the estate tax has been repealed and wondered how that will affect your estate planning.

The new law actually only fully repeals the estate tax for one year, the year 2010, and then brings back current law for the year 2011 and beyond. The conventional wisdom among tax professionals appears to be that future sessions of Congress will not allow full repeal. Instead, Congress may pick and choose from the tax relief provided in the years leading up to 2010. Therefore, we would like to focus on the changes in these intervening years.

 Marital Deduction

The 2001 Act does not change the marital deduction. Any person can give his or her U.S. citizen spouse an unlimited amount either during lifetime or at death without any gift or estate tax consequences.

Increase in Applicable Exclusion Amount (Unified Credit)

Everyone is allowed to give a certain amount, either during lifetime or at death, to anyone without it being subject to death tax. Since the Taxpayer Relief Act of 1997, this amount has been known as the Applicable Exclusion Amount. Prior to that time, we said that the unified credit sheltered a certain amount. For many years, the amount sheltered was $600,000. In 2001, the amount is $675,000.

The 2001 Act increases the Applicable Exclusion Amount as follows:

2001 $ 675,000

2002-2003 $1,000,000

2004-2005 $1,500,000

2006-2008 $2,000,000

2009 $3,500,000

2010 unlimited - no estate tax

2011 $1,000,000

Gift Tax Exclusions

  The Applicable Exclusion Amount for gift tax purposes will increase to $1,000,000 in 2002 and remain at that amount, even though the Applicable Exclusion Amount for estate tax purposes will continue to increase over time. Therefore, beginning January 1, 2002, only up to $1,000,000 may be given during life without paying tax. If gift tax is paid, there appears to be no way to receive a refund or set-off if the Applicable Exclusion Amount for the person's estate is greater than $1,000,000.

  The $10,000 annual exclusion remains unchanged by the 2001 Act. It is tied to inflation and may increase to $11,000 in 2002. We will need to wait to see inflation data, however.

Reduction in Estate and Gift Tax Rates

In 2002, the top rate decreases from 55% to 50%. The rate further decreases by 1% in each succeeding year through 2007. For years 2007 through 2009, the rate is 45%.

State Death Tax Credit

For many years, Oregon and other states have not had a separate inheritance tax. Instead, these states take a portion of the federal estate tax that is equal to a maximum credit allowed by federal law. In this way, a decedent's overall tax liability under the federal estate tax law is not increased, but the state shares in the tax.

The 2001 Act reduces the amount of the credit allowed by states and totally eliminates it in 2005. While this does not affect the amount of tax owed by an estate, it will mean a reduction in state revenues from estate tax. This may require states like Oregon to implement their own estate tax or to increase other taxes to compensate. You may see discussions in the news as the states estimate their revenue losses.

Reviewing Your Estate Plan

Many of our estate planning documents use formulas to allocate property between a Family Trust (Credit Shelter Trust) and a Marital Share or Marital Trust. On the first death the Applicable Exclusion Amount (presently $675,000) will pass to the Family Trust and the remainder to the Marital Trust. With the increasing Applicable Exclusion Amount, the amount allocated to the Family Trust will increase. This may have unintended consequences for some estates.

As long as the Family Trust and the Marital Trust are primarily for the benefit of the surviving spouse, a change in asset allocation between the trusts has no significant impact. However, a plan may call for the Family Trust to pass to children and for the surviving spouse to take the Marital Trust. The increasing Applicable Exclusion Amount will increase the amount passing to the children and decrease the amount passing to the surviving spouse. Also, some plans have the Family Trust pass to children and the remainder to charities. Again, more would pass to the children than may otherwise have been intended.

As the Applicable Exclusion Amount increases, fewer estates will require tax planning, which means fewer people will need the two-trust structure described above. For example, in year 2002, an estate of $1,000,000 or less would not require any tax planning, and the two-trust structure can be eliminated.

We are in a time of rapid change. It is difficult to predict the future of the estate tax law, but for the next few years the documents which we have drawn will be satisfactory for most clients. Our observations on the new Act do not take the place of regular reviews of your estate plan, however. If you have not reviewed your plan during the last five years, you should do so, regardless of the changes in tax law. We urge all of our clients to review their particular situations and to call us if they have any questions or concerns.