Estate Planning Under the Tax Reform Act

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The new law increases the total gift tax exemption from $675,000 in 2001 to $1,000,000 in 2002 and thereafter. The tax rate on amounts not exempt from gift tax is also reduced. It is important to note that, unlike the estate tax, the gift tax is not repealed in 2010.

The annual exclusion amount of $11,000 per year, per donor, per donee, remains in effect, as does the exclusion for gifts made by way of tuition and health care payments made directly to the provider of the services.

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The Estate Tax Has Been Replaced by a Capital Gains Tax

The new law replaces the estate tax with a capital gains tax. After the estate tax repeal takes effect in 2010, your heirs will have to pay a larger capital gains tax if they sell the assets that they inherit. Under the prior law, upon your death your assets were valued as of the date of your death. In tax language, the assets receive a stepped up basis (i.e., a new basis) as of the date of death. For example, if you purchased an asset for $1000, and if was worth $10,000 at date of death, your heir's basis in that property would be "stepped up" to $10,000, even though your basis in the asset was what you paid for it, i.e., $1000. If your heir sold the asset the next day for $10,000, he or she would not have to pay a capital gains tax.

Under the new law, if you die in 2010 (or thereafter if repeal remains in effect), your heir would receive a carryover basis. That means that your basis in the property would be carried over to your heir. Thus if you purchased the asset for $1000, that basis in the asset will be carried over to your heir, even if the asset is worth $10,000 on the date of your death. If your heir sells the asset the next day after he or she receives it for $10,000, the heir will have a $9000 gain, which will be subject to capital gains tax.

Isn't it interesting that the politicians never mentioned this when they were bragging about "eliminating the death tax?"

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Is Estate Planning Still Needed After Tax Reform?

There are at least nine different reasons to do estate planning. (One author has listed 26 estate planning goals.) The major categories are:

• Providing an easy mechanism for others to take care of you if you become disabled
• Determining who gets what, how much, when, and under what conditions
• Providing for heirs and charities, rather than the government
• Protecting your surviving spouse and heirs from predators
• Protecting your surviving spouse and heirs from creditors
• Naming and providing for guardians for minor children
• Easing administration and avoiding probate
• Reducing or eliminating estate taxes
• Reducing administration costs

Only one of the reasons is saving estate taxes. If estate taxes are eliminated, all of the other reasons remain. All of the other reasons are what might be called values-based reasons. In other words, a properly designed estate plan should focus on what you value, and how you want your values to be carried out after your death.

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Do Existing Plans Need to be Changed?

Your existing plan may or may not have to be changed. Whether or not your existing plan needs to be changed will depend upon several factors:

• The nature of your assets
• The value of your assets
• The make up of your family
• Whether your heirs are to share everything equally or unequally
• The nature and language of your existing plan documents

In any event, you definitely should have your existing plan reviewed by a competent attorney who specializes in estate planning. Because the amount that is exempt from tax will be increasing over the next nine years, and because of the way that most plans designed to save taxes are constructed, the increased exemptions could have a significant impact on which set of beneficiaries gets what.

We strongly recommend that estate plans be reviewed every year, but no less frequently than every three years. Because of the way that the increased amounts are phased in over the next nine years, plans should definitely be reviewed (under the new law as it currently exists) in each of the following years: 2002, 2004, 2006, 2009, and 2010.

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The New Importance of Record Keeping

Record keeping -- few people like to do it, and less actually do it. But now, because of the new carryover basis rules, it will be very important for every family to collect, maintain, and keep forever records on assets that will be possibly passed on after death. The new law requires that the basis of assets transferred at death be reported to the IRS and to heirs. Large penalties are imposed if the reports are not filed.

It is also very important that your heirs be able to prove to the IRS the carryover basis in each of the assets received by them, in the event that an asset is sold. The only way that your heirs can do this is if you have maintained the basis records. If an heir sells an asset that he or she has inherited, the IRS will assume that the basis in the asset is zero, unless the heir-seller can prove the actual basis. For example, assume that Daughter inherits an asset from Mother that has a basis in the hands of Mother of $100,000, then Daughter sells it for $300,000. If Daughter can prove the $100,000 basis from the records received from Mother, then Daughter's taxable gain is $200,000. But if no records are available, the IRS could treat the basis as zero, in which case the taxable gain would be $300,000 ($100,000 more).

Our advice is to start collecting and categorizing - now - all records that pertain to the basis of assets that may be passed on to your heirs, if there is even a remote chance that your heirs may sell one or more of the assets received by them.

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Why Maintenance of Your Estate Plan is Very Important

It has always been important to maintain your estate plan. By "maintaining your estate plan" we mean keeping it up to date.

Traditionally, we have recommended that estate plans be reviewed whenever certain changes occur. See our Estate Planning Alarms Checklist.

Now, under the new law, it is even more important to review plans, especially in the years 2002, 2004, 2009, and 2010. The reasons are:

• There are dramatic changes in the tax exempt amounts in those years
• Because the exempt amounts change, the design of your plan may need to be changed in order to accommodate your desires regarding the way your assets are distributed to your heirs. This is particular true if husband and wife have different sets of heirs because of prior marriages.

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