The New Estate Tax Law

The New Estate Tax Law: A Mixture Of Confusion And Uncertainty

There is so much to say that maybe the best way to say it is by starting with what others say (about the not-so-new estate tax law).

The “Conventional Wisdom” column in the June 11, 2001 issue of “Newsweek”: “What a weird tax law. If your rich dad dies in 2010, you get it all. If he lasts another year, you get fully taxed.”

William Zabel, a well-known New York estate planning lawyer: “It’s flimflam.”

Jane Bryant Quinn: “In 2010, ailing parents will keep their bedroom doors locked when their children are in the house. It’s going to be a great year to die.”

President Bush signed the new law, the “Economic Growth and Tax Relief Reconciliation Act of 2001,” on June 7, 2001. Only 12 days earlier, on May 26, both the House and Senate passed the law.

Great speed! Lousy law!

Let’s analyze the important provisions in the new law and how each provision might impact your potential tax burden. Essentially, the new law can be divided into three logical time frames:

  1. 2001 through 2009
  2. 2010
  3. After 2010

Let’s wend our way through the strange time warp of the law frame by frame. Get ready for a strange trip.

1. 2001 through 2009

The longer you live during this time frame, the less your estate tax burden might be. The following chart (“Estate Tax Phase-Out”) shows you year-by-year (1) the “Effective Exemption Amount” (the amount that can be transferred by one person free of estate tax) and (2) the “Highest Estate and Gift Tax Rate.”

Estate Tax Phase-Out
Year Effective Exemption Amount Highest Estate And Gift Tax Rate
2001 $675,000 55%+ 5% surtax
2002 $1 million 50%
2003 $1 million 49%
2004 $1.5 million 48%
2005 $1.5 million 47%
2006 $2 million 46%
2007 $2 million 45%
2008 $2 million 45%
2009 $3.5 million 45%

For example, if you go to heaven in 2008 leaving an estate of $5 million, the first $2 million will escape the estate tax, while the highest rate at which a portion of the balance will be taxed will be 45%. If you are married, double the tax-free amount in the effective exemption column.

Sorry, but those nice numbers in the effective exemption column do not apply to your lifetime gifts. The exempt gift tax amount grew from $675,000 in 2001 to $1 million in 2002 and is frozen at $1 million for the entire time frame through 2009.

I call this first time frame “the chicken soup time frame.” Why? Because it might help you, but can’t hurt you.

2. 2010

Before you read any further, remember 2010 is a one-year show. There are three major good-news-tax goodies:

  1. The estate tax is repealed.
  2. The generation-skipping transfer tax (GST) is repealed (generally, a monster tax of 55 percent on gifts — during life or at death — in excess of $1,500,000 to your grandchildren and great grandchildren). Actually, the GST is phased out during the 2001 through 2009 time frame, just like the estate tax.
  3. The highest gift-tax rate is reduced to 35 percent.

Now a new bad news rule: The stepped-up basis for each appreciated asset you owned at death (under the old law) is replaced with two make-no-sense-at-all limits: (1) $1.3 million for assets transferred to kids and their kids and (2) $3 million for assets transferred to your spouse. I won’t spend any more time explaining the rules or great planning opportunities with this nut-ball basis law. The reason?… I’m betting that future legislation kills this ill-conceived beast before it takes even one breath in 2010.

Nor can I get too serious about the three tax goodies listed earlier, either. Before 2010 dawns, we will elect many new Congresses. Do you think the estate tax law for this one-year time frame will survive unchanged? I don’t.

3. After 2010

If you see the sunrise on January 1, 2011, your dream of tax repeal will be over. Because of budget constraints, the entire new law (including the estate tax provisions) has a sunset clause that takes effect as soon as the year 2010 ends.

We will be back to square one, with the estate law being exactly the same as it was before the president signed this law. That’s progress?

What do you do now?

Bad law (particularly bad tax law, like this estate law) has a history of being changed or repealed. So, expect change. Early. And often.

Sorry, but logic dictates you must play two estate planning games at the same time: (1) assume the old law (as it was or with some modifications) will ultimately prevail. Your best bet. Or (2) assume the new law with tons of changes will win out. Unlikely. Bad law is hard to fix.

To the readers of this website, I say, “Except for the year 2010, every word I have written on this website will serve you well. If you go to the big business in the sky before 2010. Or after 2010.”

Click here if you want to learn How to Plan Your Estate Under the New and the Old Law

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