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206 S. Tennessee, PO Box 387 McKinney, TX 75070 - Phone.972.562.0777 - Fax.972.562.0780










Current Events and General Client Memos

IMPACT OF ESTATE TAX REFORM
(November 1, 2001)

As the dust settles on the estate tax reform bill passed in 2001, the only thing that is now certain is uncertainty. In an election year that found many politicians (including the President) campaigning against the "death tax," Congress felt compelled to address the issue, and the result was a mixed bag.

One dilemma faced by Congress was that in reviewing the numbers it became clear that while the estate tax is a small part of overall federal revenues today, projections were that it would produce greater revenue return in future years, as the baby boomers matured. In the end the publicity suggesting that Congress had "eliminated" the death tax was grossly overstated for the following reasons:

  • The tax-free allowance for individuals jumps from $675,000 to $1,000,000 in 2001, and has several dramatic increases through 2009, and is abated for one year in 2010, however under the law it is reinstated with a $1,000,000 exemption as of 2011. Unless you plan to die in 2010, for now assume the tax-free exemption will be $1,000,000 in 2011.
  • Congress may revisit the extra exemption given in the meantime. Nothing is set in stone. Earlier this year Congress passed a large income tax relief bill. In the wake of bailouts for New York and the airline industry, promised aid for a growing number of new "allies" and the cost of financing terrorism prevention at home and a war abroad, the budget surplus is already shrinking by the week. Congress may soon want its $300 back – and the estate tax may seem more important in the future.
  • The "estate tax" reduction was not a full tax reduction. The Congress partially paid for it in two ways:
  • Traditionally assets that are inherited get a "stepped-up" basis at death. If dad paid $2 a share for IBM and it is now selling for $100, he would have a $98 per share profit if we sold the shares during life, on which he would pay capital gains tax, albeit at the lower, 20% capital gains rate. The old law stepped-up the "basis" by allowing the persons receiving the stock at dad's death to use the date-of-death value as if it were the purchase price. As a result, the children could sell the stock for $100 after death and pay no income tax. The estate tax relief act dramatically limited the use of stepped-up basis. This means that (i) the loss of estate tax is partially offset by the recoupment in income tax, and (ii) some estates that would not have owed any estate tax at all will now be contributing income tax to the national coffer.
  • Additionally Congress previously had a cooperative system with the states to allow part of the estate tax to go to the states as inheritance tax. This was done through use of a "credit" on the federal estate tax return for dollars paid to the state for inheritance tax. The new legislation includes a phase out for that credit, so either the states will absorb the loss (unlikely) or they will alter their inheritance tax law (or other tax laws) to pass the loss back to the taxpayer.
  • When the federal law retreats back to the $1,000,000 exemption in 2011, the feds do not give back the old capital gains rules or state inheritance tax credit. In the end the feds may end up dipping more out of both the income tax pot and the estate tax pot.

In the end, most observers expect additional overhaul before 2011, but the direction of that overhaul is not certain. As the budget surplus shrinks with the war effort, it is not likely that the estate tax will disappear just as the baby boomers begin to make it worthwhile. In the meantime the best plan is to plan for change. It may be necessary to consider income tax issues along side estate tax concerns, and to update more frequently in order to play the game with precision.