Ted Koester

Article Summary:

The effects of the Economic Growth and Tax Relief Reconciliation Act of 2001 along with the planning opportunities the Act provides.

Gift, Estate And Generation-Skipping Tax Ramifications: Parts III and IV

Continued from Part I and II
III. Effects of the Economic Growth and Tax Relief Reconciliation Act of 2001 and Planning Opportunities Due to the many non-tax reasons for estate planning, the gradual phase-in of the new rules and the repeal of those rules if nothing is done by the Congress and the President in the future, one cannot afford to neglect estate planning at this time. The effects of the new laws are numerous and individuals should review their wills, trusts and other estate planning documents to ensure they take advantage of the new tax breaks and are not disadvantaged by some of the Act’s problematic effects.

One effect of the new laws may be that many individuals are now “over-insured,” even though some claim that no one is ever “over-insured”, but only “over-premiumed.” In the past many individuals have purchased life insurance as their taxable estates have grown. This was done to offset the Estate and GST taxes their estates would owe at their deaths with the life insurance proceeds. Maybe insurance coverage can now be lowered, but careful consideration must be given here since these taxes may still be incurred and the cost of later obtaining insurance may be significantly higher. Additionally, the current level of life insurance may be maintained to offset the increased capital gains taxes the property recipients may ultimately realize.

Another ramification of the new Act is that many individuals may need to execute new estate planning documents. Currently, many testamentary documents direct that the residue of the estate be divided in the following way. First, the portion that can pass tax-free pursuant to the applicable exclusion amount will usually go to beneficiaries other than the decedent’s surviving spouse. Then the remaining amount goes to the surviving spouse. Since the applicable exclusion amount is increased over the next eight years from $675,000 to $3,500,000 some individuals’ current wills and/or trusts may inadvertently disinherit their spouses or result in the spouse exercising his/her spousal rights under state law. Individuals should review their documents and the methods by which they own their assets to prevent this unintended result.

Another result of the new laws, which was alluded to above, is the new filing requirements and accompanying penalties for noncompliance placed on estate fiduciaries. The fiduciaries, and the decedent prior to her death, will need to maintain detailed records in order to complete forms the IRS will require. Based on this additional work, and these increased risks, executors’ fees will most likely rise. Similarly, the new Act requires the donors of lifetime gifts, in addition to filing gift tax returns, to notify in writing each recipient on the gift tax return of the donor’s adjusted basis in the transferred property. Failure to do so could result in the imposition of penalties.

Problems in determining the adjusted basis of assets will likely be encountered, especially for assets held for a long time or which have been transferred several times by living persons. One possible solution for the owner of such property is to donate the property to a charity. Not only will such action relieve the owner of the burden of determining his basis in the property but he will also be entitled to an income tax deduction.

Under current law, gifts made during life are more appealing than gifts made upon death. The reason being that Gift and GST taxes imposed on lifetime transfers are paid by the donor of the gift from assets other than those transferred, allowing the donee to receive the entire gift. However, Estate and GST taxes imposed on post-mortem gifts are paid from the gift before the donee receives it. That is, the dollars used to pay the tax are themselves taxed. Conversely, the new law makes retention of property more appealing than lifetime gifting. There are several reasons for this. First, the exemption amounts for Estate and GST taxes become significantly higher than the exemption amount for Gift taxes after 2003. In 2009, the exemption for Estate and GST taxes will be $3,500,000 while the exemption for Gift taxes will be only $1,000,000. Additionally, in 2010 the Estate and GST taxes go away while the Gift tax remains.

One strategy that could become popular if the repeal of the Estate tax is made permanent is the use of long-term loans. Pursuant to this strategy one will be able to avoid Gift taxes totally, yet still transfer property to others during his life, if proper planning is done. The individual could use long-term loans which will be forgiven at the lender’s death to accomplish this. However, careful drafting of the loan agreements will be necessary to limit Estate taxes while they are still in existence or if they are subsequently re-enacted.

Similarly, one could establish a dynasty trust in 2010, after Estate and GST taxes are repealed. This strategy could benefit one’s spouse and decendents for many generations into the future and likely be exempt from Estate and GST taxes forever even if these taxes are re-enacted. Gift taxes on the funding of the trust could be avoided if proper use is made of the Gift tax applicable exclusion amount and the annual exclusions for Gift taxes. However, for clients living in states that still administer a state gift tax additionally planning needs to be done to limit exposure to such tax.

IV. Conclusion
The Economic Growth and Tax Relief Reconciliation Act of 2001 significantly modifies the current Gift, Estate and GST tax laws. Some of the results are very beneficial while others could be detrimental. The ramifications to each individual will be different depending on his/her situation. We highly recommend that your estate plan be reviewed in light of new traps and opportunities resulting from the New Act.

<- Back to Part I and II

Ted Koester is an Associate Attorney with The Law Offices of Marc J. Lane, a Professional Corporation. He was admitted to the Illinois Bar in 1998. He practices in the areas of estate planning, tax law, and business law.

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