Why Estate Planning Takes on Added Importance

Before discussing some of the specifics of the Tax Relief Act, and what new estate planning strategies you should implement as a result, you should consider some factors involved in the bigger picture.

At first blush, one might conclude that estate planning is a thing of the past; no estate tax, therefore, no estate planning. In fact, this conclusion could not be further from the truth. Why?

A significant estate tax continues to exist. The new law does not repeal the estate tax until 2010; until that relatively distant date, the entire estate tax system stays put. There will be 2 presidential elections and 4 congressional elections between the date of enactment of the Tax Relief Act and 2010. A future Congress might delay the repeal date or "repeal the repeal". In fact, built into the new law is a "sunset" date of January 1, 2011, that automatically reinstates the estate tax to its full 2001 level (unless Congress acts in the meantime) with a $1,000,000 exclusion and a top tax bracket of 55% to 60%.

Many experts, including myself, believe that total repeal of the estate tax will never take place, and certainly there is no guarantee of repeal. This means that all estate plans need to be flexible. Your estate plans should be able to twist and turn as quickly as the law will during the next 10 years.

Most estate tax rates do not budge from their present, high levels until their scheduled repeal in 2010. Although the highest estate tax rate is gradually reduced by 10 percentage points over nine years (plus 5 percent attributable to the surtax for estates over $10 million), the rest of the rates, which are the rates that apply to the bulk of taxable estates, will not change. These rates range from 18 percent for taxable amounts from $0 to $10,000, to 43 percent for amounts between $1.25 million and $1.5 million mark.

Although it is a positive step, the increase in the estate tax exemption (the amount of assets automatically freed from any estate tax liability) is not substantial until 2009. In 2002 and 2003, for example, only $300,000 more in assets are exempt from estate tax than would have been under the old rules. Add to the equation what inflation will do to the value of these exemptions during the next 10 years, and it is clear that the new exemptions will not provide the level of estate tax relief many estate owners had hoped for.

The gift tax will not be repealed. This means that you may continue to encounter problems in giving a son or daughter substantial funds for a first home or an emergency, or passing a family business along to the next generation gradually as a reward or incentive to continue your business. Additionally, the amount of the exemption for gifts to a non-citizen spouse is limited. In 2002, that exemption is only $110,000.

You will now need to contend (or, more accurately, your heirs will have to contend) with additional income tax, scheduled to appeal on the scene when (and if) the estate tax is phased out. Any individual with an estate with a potential value exceeding $1.3 million (in post-2010 dollars) should anticipate that the heirs may have to pay additional tax down the road as a result of the new "carryover basis" rules.

State tax authorities will be pressured to continue a significant estate tax on the state level to maintain much needed revenues. "Piggybacking" state taxes to federal taxes, which many states now do, will become less common. This means additional complexity for your total estate planning strategy, as states begin to reach for a means to replace their "pickup taxes," which will expire when (and if) the federal estate tax repeal becomes effective in 2010.

As you can see, estate planning has gotten more complex and, for many taxpayers, more important than ever.

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