The Tax Relief Act of 2001

The Tax Relief Act of 2001

How the Act affects the federal estate tax – and what you should do about it

By Alan G. Orlowsky, J.D., C.P.A.

A version of this article was published in Personal Finance, July 11, 2001. It was updated September 2002 and April 2008. Reports of the death tax´s death have been greatly exaggerated. Congress did manage to repeal the tax for people who die during the 2010 calendar year. But for everyone else, although the rates and exclusions will change frequently over the next ten years, there will be still be a death tax. In fact, absent future Congressional action to the contrary, the estate tax will rise again in 2011, like a nightmare ghoul in a trashy “Friday the 13th” sequel.

Here is a simplified version of the changes that Congress made to the federal estate tax (fondly known as the death tax) as a result of the Tax Relief Act of 2001:

  • The estate tax exclusion (also known as “credit equivalent”), currently at $1 million (double that for couples), will increase to $1.5 million in 2004, $2 million in 2006, and $3.5 million in 2009. Then it will disappear in 2010. Then it will revert back to $1 million in 2011. The exclusion is the amount that you can pass along to your heirs free of estate tax; everything above that level is subject to the tax. Under the previous plan, the exclusion was scheduled to rise only to $1 million by 2006.
  • The highest marginal estate-tax rate, now 50 percent, will fall to 49 percent in 2003, and by 1 percent per year until it reaches 45 percent in 2007. Then it’ll spring back to 55 percent in 2011. Under the previous plan there was no scheduled rate reduction.
  • Under current law, when you pass stock and other assets that have appreciated in value to your heirs, they get a step-up in basis to market value at the time of your death. Under the new law, in 2010 there will be no automatic step-up in basis – your heirs will probably inherit your original (carryover) basis along with your appreciated assets, possibly resulting in higher capital gains tax when they sell the assets. But then, ta-da, in 2011 the step-up in basis returns.
  • Under the new law, upon your death your estate may increase the basis of appreciated assets by up to $1.3 million, and by an additional $3 million for a spouse. But only until 2011.

What action you should take in response to the changes in the estate tax depends mainly on the value of your estate. It also depends, of course, on when you die – but most people can’t plan that. For the purposes of estate planning, you must assume (from a purely detached, hypothetical point of view) that you might die any moment.

Action plan

So how can you plan your estate in the midst of this confusion? First of all, no changes will take place until next year, so there is no urgent need to take action. But you may want to do so before the end of this year.

Long-range planning can get tricky. You should take into account that there is a reasonable likelihood that Congress will revise the estate tax law all over again within the next ten years. So the best strategy in many cases is to plan for a year-2009 scenario, when the exclusion amount reaches $3.5 million and the maximum marginal tax rate falls to 45 percent. For example, if you have a revocable trust with assets greater than $1 million, you may consider gradually increasing the value of trust assets up to $3.5 million by 2009. But do so only with advice from your lawyer, because you’ll need to position your assets and coordinate your beneficiary designations properly to accomplish the funding of the trust. If you have a revocable trust with assets worth less than $1 million (or less than the revised exclusion amount in any future year), you should keep the trust in force to avoid probate, but probably need no further action with respect to the trust.

Gifting strategy

For people with modest estates, gifting strategies, which take advantage of the $12,000 annual gift tax exclusion, are less imperative now that the estate tax exclusion is increasing. But for those with large estates, gifting is just as important now as before, and they should establish gift trusts for their family members. If the estate tax is really abolished and the gifting turns out to be unnecessary, so much the better. But if the tax gets resurrected in 2011 as planned, gifting may save you literally millions of dollars.

If you plan to pass to your heirs assets that will appreciate significantly in value by 2010, you might want to purchase a life insurance policy with a ten-year term. Such a policy will help your heirs pay the capital gains tax they’ll incur if they inherit the assets with the carryover basis. The Tax Relief Act nine-year phase-out has not eliminated the need for smart estate planning. In fact, the Act has made planning more uncertain and complicated. If you’re not sure what to do about the changes, meet with your lawyer and financial adviser to evaluate your current estate plan in light of the new law – which will probably change again well before 2010.

New Estate Tax Provisions

Year
Exclusion
(dollars)
Top marginal
tax rate (%)
Basis
2001
675,000
55
Step-up
2002
1 million
50
2003
49
2004
1.5 million
48
2005
47
2006
2 million
46
2007
45
2008
2009
3.5 million
2010
0
Carry-over
2011+
1 million
55
Step-up

Blank cell = no change from pervious year

About the Author

Alan G. Orlowsky, President of Orlowsky & Wilson, Ltd. in Lincolnshire, Illinois, has been counseling people on estate planning for 28 years. He previously worked for the IRS in its Estate and Gift Tax Division. He also worked for the Deloitte & Touche accounting firm, and he has taught taxation and accounting at Loyola University of Chicago, School of Business.

Al is a contributing author of the book 21st Century Wealth (Esperti Peterson Institute, Denver, 2000), and has written numerous articles on the subject of estate planning. Contact Alan Orlowsky by email or call 847-325-5559.

  • Email
  • Mailing Address
    250 Parkway Dr. Lincolnshire, IL 60069
  • One Northfield Plaza 560 W Frontage Rd STE 300 Northfield, IL 60093
  • 115 S LaSalle St STE 2600, Chicago, IL 60603

Quick Contact