By Ryan M. Wilson (originally published May 2005)
On April 13, 2005, the U.S. House of Representatives by a vote of 272-162 approved H.R. 8, the Permanent Estate Tax Repeal Act of 2005. A substitute amendment by Earl Pomeroy (D-ND) to increase the estate tax exemption amount was defeated by a vote of 194-238. The U.S. Senate has yet to take up a similar bill. However, the passage of the House bill is an encouraging sign.
Background. The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 gradually eliminates the estate tax by increasing the amount that is exempt from the tax over several years, reducing the top rate over several years, and finally repealing the estate tax for individuals dying after 2009. But there is a quirk in the law. To comply with budgetary rules, the 2001 Act contains a so-called sunset rule under which the pre-2001 Act rules return after 2010 unless Congress provides otherwise at some future time. This means that the estate tax is repealed only for those who die in 2010.
Under EGTRRA, there is no estate tax on the first $1.5 million for 2005, $2 million for 2006 through 2008, and $3.5 million in 2009. There is also a change to the unified system. The gift tax exemption amount remains at $1 million for all years after 2001, and the gift tax is not being repealed during 2010 as the estate tax is. Only the estate tax exemption amounts will rise to more than $1 million. Under the sunset rule, the exemption will go down to $1 million for both estate and gift tax purposes in 2011.
The top estate and gift tax rate dropped to 47% in 2005. It will drop to 46% in 2006, and 45% in 2007 through 2009. In 2010, there will be no estate tax and the top gift tax rate will be 35%. Under the sunset rule, the top estate and gift tax rate reverts to 55% in 2011.
Uncertain impact on planning. The uncertainty of whether the sunset provision will ever come into play and whether an individual will die during a period of increasing exemption amounts makes planning difficult. Also, the way the law works, when income tax costs are factored in, some heirs will face higher tax costs if their benefactor dies in 2010 when the estate tax is repealed than they would if he died before 2010.
What to do now. Individuals should continue to write wills and trusts and develop estate plans to ensure that their assets will pass as they desire and that special needs of particular heirs will be properly addressed. This is so even if there is a good chance of survival until a year when estate tax won't be owed because of the increasing exemption or repeal. Individuals who may have an estate larger than the increasing exemption amount (or the $1 million amount that will apply for 2011 after estate tax is restored one year after it is repealed) should make annual exclusion gifts each year.
The gift tax annual exclusion allows you to give $11,000* to an unlimited number of donees each year without paying gift tax. By doing this, you remove the gift amounts from your estate and save estate tax. In addition, you remove the post-transfer growth in the gifts from your estate. Other steps to reduce estate tax include setting up a life insurance trust, establishing a grantor retained annuity trust (GRAT), and placing one's residence in a special type of trust called qualified personal residence trust (QPRT).
Special factors for married couples. Married couples should make sure that each spouse has sufficient assets to take advantage of the increased exemption. Also, their wills and trusts should establish a so-called bypass or credit-shelter trust. Such a trust is funded with an amount equal to the exemption from estate tax. The survivor gets income from the trust and the assets in the trust pass to the children free of estate tax on the survivor's death. Assets above the exempt amount can be given outright to the surviving spouse or placed in a special marital trust for him or her. This approach may have to be altered depending on the year involved and the size of the estates.
New look at plan. Unfortunately, we cannot count on the U.S. Senate to duplicate the House bill. We have been down this road before and the Senate has stalled similar legislation. The 2001 Act saves estate tax to the benefit of your heirs, but it has added many new planning complications. I invite you to contact our office to set up an appointment so that we can properly reexamine your estate plan to help to keep your estate tax, and income tax for your heirs, to a minimum.
Mr. Wilson practices Probate Law, Estate Planning, Real Estate and Business Law in the Lansing office. He may be contacted at 517.377.0897 or rwilson@fraserlawfirm.com.
* This amount increased to $12,000 in 2006.
This summary is intended as a source of general information. If you have questions or desire additional information, please contact Ryan M. Wilson at (517) 377-0897 or rwilson@fraserlawfirm.com.