Estate Taxes. (You're kidding right?)

July 30, 2003 Published Work
Family Equity, A Publication of The Center for Family Business at the University of New Haven, June 2003.

Estate Taxes

(You're kidding, right?)

Actually, no.
The federal estate tax is still with us. You will, no doubt, be amazed to learn that the recent changes to the federal estate tax law, compliments of the Economic Growth and Tax Relief Reconciliation Act of 2001(fondly referred to as "EGTRRA"), bring a heretofore unknown level of uncertainty to the world of estate planning. On the bright side, if your death occurs in a propitious year, your heirs could in fact benefit mightily (although perhaps in a manner different from the one you intended) from the temporary changes that our government has so generously bestowed. Here's the much-abbreviated story.
Under the federal transfer tax system, each individual is entitled to a tax credit enabling him or her to gratuitously pass a certain amount of property either during life or at death, or a combination of the two, without generating a federal gift or estate tax liability. Once you consume this tax credit, known as the "unified credit" or more properly the "applicable credit amount," additional lifetime or testamentary transfers are generally taxed at progressive rates beginning at 37 and rising to 49 . In 2001, the applicable credit amount was $675,000. Beginning with 2002 and continuing over the next several years, the EGTRRA changes unfold. A summary of the changes with respect to the estate tax applicable credit amount is presented in the following chart.
Year Estate Tax Top Tax
Exemption Rate

2002 $ 1,000,000 50
2003 1,000,000 49
2004 1,500,000 48
2005 1,500,000 47
2006 2,000,000 46
2007 2,000,000 45
2008 2,000,000 45
2009 3,500,000 45
2011 1,000,000 55

I know what you're thinking, but that is not a typo. As things now stand, the estate tax is fully repealed in 2010, only to return in 2011 in all of its present day glory - and then some, if you take into account 2011's top tax rate of 55 . The repeal of the repeal, or the "sunset provision" was included so that EGTRRA would not be caught in the talons of the Byrd Rule (which would have required a 3/5 or 60 senate majority vote to make the repeal permanent).
  • It is difficult to imagine that Congress will permit a full sunset to occur.
  • It is more difficult to imagine exactly what Congress will do.
  • It is still more difficult to imagine a more uncertain estate planning terrain to navigate.
Notwithstanding all this untidiness, there are some key steps you should consider taking. First and foremost, a review of your Will or Revocable (Living) Trust is in order to determine whether EGTRRA causes the terms of that document and your desired intent to part ways. This is the case for a large number of the most common existing estate plans, known as "A/B" plans. Under a common A/B testamentary plan, the first spouse to die leaves property having a value equal to the applicable credit amount to a family trust for the benefit of the surviving spouse and children. The balance of the deceased spouse's estate passes either outright to the surviving spouse or is held in a marital trust for his or her sole benefit. This has traditionally been a preferred dispositive scheme because it makes full use of each spouse's applicable credit amount and defers any estate taxes until the death of the surviving spouse (assets in excess of the applicable credit amount that pass to a marital trust or outright to a surviving spouse are not taxed until the death of the surviving spouse).
The property dispositions pursuant to the A/B plan described above change dramatically with the increasing applicable credit amount under EGTRRA. For instance, assume Husband has a $2,500,000 estate and an A/B Will that establishes an applicable credit amount family trust, with the balance of the property passing outright to Wife. If Husband dies in 2003, the family trust will be funded with $1,000,000 and Wife will receive an outright distribution of $1,500,000. If Husband dies in 2009, the family trust will be funded with $2,500,000 and Wife will receive $0 outright. For some people, having substantially more assets than anticipated held in trust for their spouse and children may not be a problem. For many surviving spouses, however, it will be a nasty surprise. And for some family business owners, this can mean that the control of a business interest will not pass to the intended recipient. The moral is that the wise, review and revise (as necessary, of course, and with competent, professional assistance).
You may also want to consider making lifetime gifts. A properly structured gifting program can significantly reduce the amount of your assets ultimately subject to transfer taxes with minimal gift tax consequences. And, since it's really anyone's guess as to what estate taxes, if any, will be imposed at your death, a smart gifting program may prove especially beneficial. There are any number of gifting techniques available, from straightforward, outright cash gifts of the annual exclusion from gift taxes amount (currently $11,000 per donee per year), to sophisticated plans designed to leverage lifetime gifts of business interests. Charitable trusts can be used to benefit charity and provide a tax advantaged gift to family members. Lifetime giving can also include entities such as limited liability companies and limited partnerships which provide the donor with continuing control over the gifted assets as well as creditor protection and transfer tax advantages. Be wary, however, because a gifting strategy is of little value unless it meets both your donative desires and your estate and business succession planning goals.

So, as you can see, I was not kidding. Estate taxes have not gone away, may not go away and could be subverting your testamentary intentions. A little planning now might prevent a lot of heartache later.