Weekly Newsletter 04/17/01The President's plan to repeal transfer taxes |
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President Bush is busy trying to promote his $1.6
trillion tax plan to Congress and the American people. One component of
his plan is outright repeal of the estate, gift and generation-skipping
transfer (GST) taxes. This Practice Alert examines the history of
transfers taxes, an unsuccessful bid to eliminate them last year,
details of the President's plan to repeal them, and its prospects for
success. History of transfer taxes. The Federal
estate tax came into being in 1916, and, to prevent taxpayers from
avoiding it by giving away a substantial part of their assets during
life, a permanent, cumulative gift tax was enacted in 1932. The current
unified gift and estate tax system was enacted in '76, and the current
generation-skipping transfer (GST) tax was enacted in '86. Last year
both houses of Congress passed by large majorities, the Death Tax
Elimination Act of 2000. This bill would have reduced estate and gift
tax rates over several years, and completely repealed those taxes for
decedents dying and gifts made after 2009. It also would have eliminated
a step-up in basis after repeal was complete except for $1.3 million of
assets generally, and up to $3 million of assets passing to a surviving
spouse. President Clinton vetoed the Death Tax Elimination Act of 2000,
and his veto was sustained. President's proposal would lower rates before outright repeal. Under the proposal Mr. Bush submitted to Congress on February 8, 2001, Federal estate, gift and GST taxes would be repealed for gifts made and decedents dying after 2008. Until then, each of the current estate and gift tax rates would drop by 5 percentage points for 2002 and 2003, 10 percentage points for 2004, 15 percentage points for 2005, 20 percentage points for 2006, 30 percentage points for 2007, and 40 percentage points for 2008. Thus, under the President's plan, the maximum estate and gift tax rates would be: ...50% in 2002 and 2003, ...45% in 2004, ...40% in 2005, ...35% in 2006, ...25% in 2007, and
...15% in 2008. In 2008, the maximum estate tax rate would be lower
than the long-term capital gains rate (assuming today's 20% rate
continues). This could present a planning opportunity in conjunction
with alternate valuation, which would continue and which allows assets
to be valued six months after date or on their earlier disposition, if
doing so produces a lower estate tax bill. Estates and their
beneficiaries could be better off if executors paid a slightly higher
estate tax by not electing alternate valuation even though they could.
This would give the affected assets a higher basis and could yield
capital gain savings on their later sale at a higher price. The savings
could more than offset the higher estate tax. How the President's plan would affect the unified credit. The unified credit would be reduced the same way the estate and gift taxes are reduced since that credit is not a fixed amount. Instead it is equal to the tentative tax (calculated using the unified estate and gift tax rate schedule) on "the applicable exclusion amount." ( Code Sec. 2010(c)) The applicable exclusion amounts, which under present law are scheduled to increase to $1 million in 2006, would not be increased under the Bush proposal. Thus, under his plan, the unified credit based on the applicable exclusion amount in effect for each year would be: ...194,800 in 2002 and 2003 (exempting the first $700,000 of transfers), ...$202,300 in 2004 (exempting the first $850,000 of transfers), ...$183,800 in 2005 (exempting the first $950,000 of transfers), ...$146,000 in 2006 (exempting the first $1,000,000 of transfers), ...$52,000 in 2007 (exempting the first $1,000,000 of transfers), and
...$0 in 2008. observation: The unified credit would be
zero in 2008 because the 40 percentage point reduction in rates for 2008
would result in no tax being owed on taxable estates of $1 million (the
applicable exclusion amount for 2008 that would continue from present
law) or less. Impact on current giving. An individual who
is considering making a large taxable gift this year could save a
sizeable amount of tax by holding off on making the gift until next year
if the President's plan is adopted. illustration: Mary Jones, a widow, makes
gifts each year to her five children in an amount equal to the annual
exclusion. She has never used any part of her unified credit. This year,
she has already given each child an annual exclusion gift and is
considering giving each of them an additional $200,000, for total
taxable gifts of $1 million. How much gift tax would she owe on this
total of $1 million in taxable gifts? In 2001, the gift tax on $1
million is $345,800, and the allowable unified credit based on an
applicable exclusion amount of $675,000 is $220,550. Thus, if she went
ahead with the gifts, Mary would owe a net gift tax of $125,250. illustration: If Mr. Bush's tax proposal is
passed, and Mary delays making her gift until 2002, the gift tax on $1
million would be $295,800, and the allowable unified credit would be
$194,800 (on an applicable exclusion amount of $700,000 in 2002). Thus,
Mary's net tax due would be $101,000. As a result of assumed passage of
the Bush estate and gift tax proposal and the scheduled increase in the
unified credit under current law, Mary would save $24,250 in gift taxes
by delaying making the gifts until 2002. observation: Of course, it will not always
be feasible to delay making gifts. For example, one or more of Mary's
children may need funds now for some worthwhile purpose like buying a
home or starting a business. caution: In deciding whether to delay making a gift to take advantage of the lower rates if Mr. Bush's bill becomes law, factors other than the tax rates should be considered. For example, if a taxpayer plans to make a gift of stock and he/she expects the value to increase substantially before 2002, gift taxes could actually be lower if the gift is made now even if the gift tax rates are in fact lower next year. No carryover basis under Mr. Bush's plan.
As noted above, the bill Congress passed last year provided for a
carryover basis (with some exceptions for smaller estates). Mr. Bush's
bill, however, continues to provide for a new basis equal to
date-of-death fair market value even after the estate tax is completely
repealed, and regardless of the size of the estate. observation: This would allow many very
wealthy individuals to pay no tax on appreciation in assets they pass
from generation to generation. illustration: In 2009, Smith buys $2 million
worth of stock that he holds until he dies in 2012 when it is worth $6
million. His children inherit the stock and they immediately sell some
of it for its date of death value. Under the Bush proposal, no estate
tax would be owed on the value of the stock and no income tax would be
owed on its sale by the children. Under current law, the income tax
result would be the same for the children but the value of the stock
would be subject to estate tax. Suppose Smith's children, from the prior Illustration, need some funds before Smith dies. Smith could sell some stock or give the children some stock and they could sell it. In either case, however, capital gains tax would have to be paid. Under the Bush proposal, they may have another option that would allow them to cash in the stock at no tax cost. illustration: Smith could give shares to his dying
father, who, in turn, could leave them to the children. Under the Bush
proposal, there would be no gift tax on the transfer of the shares to
Smith's father and there would be no estate tax on the shares at his
death. Moreover, the children would get a step-up in basis and could
immediately sell the shares at no income tax cost. This would be
possible even if Smith's father died one day after receiving the gift
from Smith. Code
Sec. 1014(e) prevents a step-up in basis for some transactions like
this, but only when the donee dies within one-year of the gift and
leaves the donated property to the donor or the donor's spouse. This
doesn't apply when the donee leaves the property to a child of the
donor. Even now, one can transfer property to a dying parent who, in
turn, could leave the property to a child of the donor to achieve a
step-up for the child. However, under present law, the transfer to the
parent would be subject to gift tax (except to the extent shielded by
the annual exclusion and/or unified credit) and the transfer from the
grandparent to the grandchild would be subject to estate (except to the
extent shielded by unified credit) and possibly GST tax. observation: It's hard to imagine that
transfer taxes could be repealed without some kind of elimination of
step-up in basis. Without a carryover basis mechanism, it would be too
easy for individuals to completely avoid many forms of taxes. Opposition to complete repeal. Opposition has been developing to complete repeal of the estate and gift taxes. Some very wealthy Americans have said that the estate tax should not be completely repealed even though some reform such as increasing the effective exemption amount may be in order to keep farms and small businesses from having to be sold after the owner's death. Many have also expressed concern that charitable giving will be reduced if transfer taxes are completely repealed. The life insurance industry also would suffer. States also would lose revenue in that many states impose death taxes in an amount equal to the Federal credit for state death taxes. If Federal estate tax were repealed, these states would have to look to other taxes to make up the lost revenue, or would have to impose an estate or inheritance tax not based on the Federal credit.
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