Brown & Associates - Attorneys & Counselors at Law, P.L.L.C.

CONGRESS REPEALS DEATH TAX(?)--THE FINAL EDITION
(7/22/01)

I could probably go on forever because Congress and the President have wrought the most significant changes to the income and estate tax rules in many an age. I'm sure, however, that your patience has worn thin and you are ready for me to move. With that in mind, I'll wrap up my discussion of the 2001 Tax Relief Act with just a few more comments.

Effect of the Law on State Revenues

If you didn't know it, the Act will have a significant impact on the states, one that may not have been obvious from the outset. It reduces the State Death Tax Credit by 25 percent in 2002, 50 percent in 2003, and 75 percent in 2004. It then converts the credit to a deduction in 2005.

The net effect of this is to transfer most of the costs of the increased "Exempt Amount" ($675,000 and climbing to $1 Million in 2002) from the federal government to the states. According to some estimates, the cost to the states could be in the billions of dollars and could lead the states able to do so to enact entirely new state inheritance taxes.

This is a moving target, so stay tuned. If there are further developments, you will hear about them here.

More on the loss/limitation on "Step-up" in Basis

Earlier I advised you about the loss of basis "step up" under the new law, subject to certain exceptions. If you missed these articles, you can find them posted on our website at www.brownlaw-ok.com. There you'll find them listed by title and date of publication.

Because of the change in "basis step up" rules, it will become more important to allocate your low basis business assets between the spouses so as to take advantage of the limited "step up" in each of your estates.

You also need to look at the "basis eligibility requirements" before settling on a plan of distribution since not all assets are equal when it comes to the allowable step-up-in-basis.

Because of the increasing exemptions and ultimate repeal of the federal estate tax (for 1 year), owners of farms, ranches and family businesses won't be as eager to transfer their ownership interests to the children or to relinquish control of their businesses before they are absolutely ready to step down.

The repeal of estate tax, if it happens, will allow owners to make common sense (rather than tax avoidance) decisions. That is, you can look at what makes the most sense from a family and business standpoint, instead of worrying about complex business structures or transfer plans to protect your businesses from the dreaded federal estate tax. Of course, this is all dependent on the federal estate tax staying repealed and right now all bets are off. No one is ready to say the repeal will "stick."

For now we have repeal on the books, so if you own a farm, ranch or business, you need to review your existing estate plan to see if it makes sense and accomplishes your goals. It should provide maximum flexibility so you can meet your needs and expectations no matter what happens in the future. This is easier said than done, but there are enough options that you should be able to approach (if not achieve) all your estate planning requirements.

What effect do the changes in the law have on the use of QTIP Trusts?

That's an excellent question. The QTIP trust (which I discussed in an earlier column) has been and will continue to be a very useful estate tax planning tool, especially for those of you in second marriages. It guarantees your spouse the right to receive income from the assets in the trust while ensuring the principal is there for your children. It also qualifies the assets for the additional $3 million dollar step-up in basis available for property passing to the surviving spouse. This gives you a double bang for your buck.

If we assume the federal estate tax will stay repealed, those of you in second marriages won't need to worry about equalizing your estates to take advantage of estate tax credits. This means you can keep your existing assets in your own names through an antenuptial or premarital agreement and use the QTIP trust to take advantage of the step-up in basis.

Will this reduce what has to be done after someone dies?

Not necessarily. It seems as if post-mortem actions should be reduced following repeal of the estate tax, but this may not be true. When the estate tax repeal and limited step up begin on January 1, 2010, you won't have to "split" trusts to fund credit shelter, marital deduction or QTIP trusts, but the limited "basis step-up" will be a problem. You will need to trace the basis of a decedent's assets, calculate the tax effect of possible sales and distributions, and fulfill the decedent's distribution plan while taking full advantage of the $1.3 million allowance and the $3 million spousal allowance. This may not be as easy as it sounds.

In the past, this wasn't a problem. Everything qualified for a "stepped-up basis" so you could sell it and distribute the proceeds to beneficiaries without worrying about tax implications. Now you will need to carefully weigh which assets to qualify for the basis step-up since the sale of appreciated assets will result in capital gains tax. This means you will need to inventory assets and determine the basis of each, which places a premium on accurate record keeping--something that hasn't always been a strong suit with taxpayers.

How can I plan in a period of such uncertainty?

First, review your existing plan to make sure it is flexible enough to fit your situation. Second, if you have a lifetime giving program, monitor your giving so you don't exceed the allocable gift tax exemption. Next, determine the tax basis of your property and make sure it is accessible to your trustee or personal representative. Finally, stay in touch with your estate planning professional. He or she will keep you current on changes in the law and advise you of any necessary modifications to your estate plan.

To return to the Strategic Planning Articles click here.