Estate Tax Basics

Congress made numerous changes to the estate and gift tax laws in the 2001 session. Most of these took effect in January, 2002.

The law made a number of changes to the estate tax, the gift tax and the generation-skipping transfer tax. The changes reduce these taxes by lowering the rates and increasing the exclusion amount until 2010 when the estate tax and the generation-skipping transfer tax are repealed for individuals who die (or make generation-skipping transfers) in that year. The taxes are reinstated for 2011 and years thereafter at the rates and with the exclusion amounts that were in place before the new law was enacted. The gift tax is retained for all years. Here are some of the specific changes:

Gift Taxes.  The law has different rates for gift taxes and estate taxes. (Gift tax applies to gifts you make during your lifetime, estate tax applies to gifts you make at death.)  Effective January 1, 2002, the  credit for gift tax  exempts from tax the first $1 million of gifts.  It remains at that level through 2010.    When the estate and generation-skipping taxes are repealed in 2010, the gift tax continues in existence. The credit will continue to exempt lifetime transfers of up to $1,000,000. The top gift tax rate will be 35%. The annual exclusion (generally $12,000 per donee), as well as the exclusion for payment of medical and educational expenses, will continue to apply, as will the deductions for charitable and marital gifts.  The limitation on gift taxes is intended to ensure that you do not take advantage of the estate tax repeal to make huge gifts in 2010.  You have to die in that year to benefit from the repeal.

Estate Taxes. The exclusion for estate tax increases until it is repealed in 2010.  In 2011, the estate tax is reinstated at its 2002 levels. The value of all gifts made subject to the gift tax must be added to the value of the estate at death to determine the amount of the exclusion.  The "applicable exclusion amount", is the amount you can give at death, free of tax.  The applicable exclusion amount for each year is as follows:

Year of  Death                  Applicable Exclusion Amount

2006-2008                         $2 million
2009                                    $3.5 million
2010                                    no tax
2011                                    $1 million

Tax Rate. The generation-skipping transfer tax rate continues to be equal to the highest estate tax rate. The estate tax rate for each year is as follows:
Year   Tax Range

2007     Flat 45%
2008     Flat 45%
2009     Flat 45%
2010       Repealed
2011    41% - 55%

Basis Rules. Through 2009, the law preserves the rule that steps up (or down) basis in an asset transferred at death to its fair market value at the owner's date of death.  In 2010, the only year in which the estate tax is repealed, the step-up in basis is eliminated, and assets transferred at death generally take a carryover basis.  In no event can the additional basis be allocated such that an asset has basis in excess of its fair market value. The current step-up in basis for all assets transferred at death is reinstated in 2011 when the estate tax is reinstated.

If your estate is likely to be subject to estate tax, you should consider different planning options that will enable you to reduce the estate tax due at your death.  If you are married, you might chose an A-B or Bypass Trust in order to get the benefit of both spouses' exclusions.    The A-B Trust plan also allows you to ensure that the survivor cannot change the beneficiaries of the first spouse to die's share of the estate and may protect some of the estate from creditors of the surviving spouse (possibly excluding Medi-Cal claims).  You might also be interested in other planning tools, such as Irrevocable Life Insurance Trusts,  Intentionally Defective Grantor Trusts,  current gifting plans, and Family Limited Partnerships.