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Law Offices of Jimmie L. Joe
A Professional Law Corporation
17700 Castleton Street, Suite 358
City of Industry, California 91748
Phone: (626) 839-8980
           (888) 988-3488


THE ECONOMIC GROWTH AND TAX RELIEF ACT OF
2001


On June 7, 2001, President Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 (the “Tax Relief Act”) into law. The Tax Relief Act gradually reduces the estate tax until it is eventually abolished in 2010. The Tax Relief Act changes affect drafting and planning considerations of attorneys engaged in estate planning. Estate plans of the past may require reexamination and redrafting to take into consideration some of the tax changes. This outline is meant to summarize the highlights of the Tax Relief Act. However, it is not intended to be legal advice and you should always seek the opinion of a qualified estate planning professional who has evaluated the facts and circumstances of your individual case.
The Tax Relief Act increases the estate tax lifetime exemption from the previous $675,000 amount to $1,000,000 effective January 1, 2002. The exemption increases over the next eight years until January 1, 2010 when the estate tax is abolished. In addition, the estate tax rates will decrease over the years 2002 to 2009. The following table summarizes the increased estate tax exemptions and decreased rates.

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CALENDAR
YEAR

ESTATE AND GST TAX

TRANSFER EXEMPTION

HIGHEST ESTATE
AND GIFT TAX RATES

2002

$1 Million

50%

2003

$1 Million

49%

2004

$1.5 Million

48%

2005

$1.5 Million

47%

2006

$2.0 Million

46%

2007

$2.0 Million

45%

2008

$2.0 Million

45%

2009

$3.5 Million

45%

2010

No Estate Taxes

0%

2011

$ 1 Million

55%

  

GIFT TAXES

The Tax Relief Act does not abolish the gift tax. The gift tax rates will decline annually until 2010, when the highest marginal gift tax rate will be equivalent to the highest income tax rate (35%). The Act provides for a $1,000,000 lifetime gift tax exemption, which does not increase annually like the estate tax exemption. Thus, after 2002 you will be able to exempt up to $1.0 Million from gift taxes. In addition, the current annual exclusion amount from gift tax is increased to $11,000 annually. Thus, a donor will be able to gift up to $11,000 annually without incurring any gift tax.

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GENERATION SKIPPING TAX

The Tax Relief Act also changes the generation skipping tax (GST). The GST is a second transfer tax imposed at the highest estate tax rate when property is transferred to a “skip” generation heir (i.e. grandchild). This can occur as an outright gift from parent to child or a transfer in trust by parents to a child in trust with the remainder to a grandchild. The GST is taxed as if the property did not “skip” a generation but, instead, was included in the skipped generation’s estate (i.e. taxed to the children before passing to grandchildren). The exemption for GST transfers, which was $1,060,000 in 2001 increases to 1,090,000 in 2002, and increases in 2004 to equal the estate tax exemptions above. The GST rate is set at the highest estate tax rate in effect when the tax is due. Thus, the rate will gradually decline from 55% in 2001 to 45% in 2007. The GST is abolished, effective January 1, 2010.

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LIMITATION ON STEPPED-UP VALUATION

The Tax Relief Act also changes the prior law related to “stepped-up” valuation. Under the prior law, property was given a “stepped-up” valuation at death to the fair market value. This meant that if an individual had purchased a home thirty years before his death at $50,000 and the home was worth $250,000 at his death, the property was given a “stepped-up” basis as of the date of death to the $250,000 fair market value. Thus, if the home were subsequently sold, the beneficiaries of the deceased person’s estate would not be subject to capital gains tax.

However, the Tax Relief Act imposes a limitation on the carry-over basis for property received from a decedent after January 1, 2010, when the estate tax is abolished. Heirs will inherit a decedent's property with a cost basis equal to the lesser of the deceased person’s adjusted cost basis or the fair market value of the property on the date of the deceased person’s death. The deceased person’s executor or administrator is then permitted to increase the adjusted cost basis in the deceased person’s property up to a limit of $1,300,000 (the cost basis may be decreased if the fair market value is less than the cost basis before death). For certain property transferred to a surviving spouse, the basis may be increased up to $3,000,000. Certain property (retirement plan assets) would not qualify for the cost basis adjustment.

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SUNSET PROVISION

Despite the passage of the Tax Relief Act, the estate tax may never be permanently abolished. The tax Relief Act has a “sunset provision”, which means that after 2010, the elimination of the estate tax will require Congress to re-enact the legislation to keep the repeal alive. If Congress does not vote to abolish the estate tax after the Congressional elections of November 2010, the estate tax goes back to the way it was before the tax Relief Act was enacted. Moreover, who knows what changes might occur over the next ten years with shifts in power to new Presidents and legislative members. The sunset does create uncertainty over whether the estate tax will actually be abolished. What happens in the future depends on future economic and budget conditions and the political players involved.

If history is any indication, the permanency of tax cuts has always been uncertain, especially tax breaks for higher-income individuals. Just look at the lowering of the highest marginal tax rate by the Tax Reform Act of 1986. The highest rate was decreased from 50% to 28%. However, the decrease was short lived after deficit problems lead to the elevation of the tax rate to 31% in 1991 and to 39.6% in 1993.

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ESSENTIAL NEED FOR ESTATE PLANNING

Our fundamental approach is to recommend that clients have their estate plans reviewed at least every other year. The Tax Relief Act presents a number of drafting challenges for the estate planner. For example, trusts created in the past that currently fund the credit shelter trust to the maximum available exemption amount may no longer be appropriate where family assets do not exceed the increased exemption amounts. Gifting of assets anticipated to appreciate over time, which was once an effective planning strategy, may no longer be advisable with the expanding gap between the gift tax and estate tax exemptions. It may be advantageous to transfer such assets at death when the appreciated value can be offset against the increased estate tax exemption instead of during one’s lifetime, when the transfer is limited to the $1,000,000 gift tax exemption. Life insurance policies purchased to hedge against estate taxes may require review to determine their appropriateness. Estate planning is also essential to provide for disability, determining to how one’s assets are to be distributed, who gets what, when and how much, providing for charities in lieu of taxes, protecting one’s surviving spouse and children from creditors, naming guardians for minor children and avoiding probate. Rather than embrace the false sense of security brought about when news of the Tax Relief Act’s elimination of estate taxes was announced, it is our opinion that proper estate planning is now more essential than ever for wealth preservation.

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The information contained on this website is not intended as a source of legal advice. You should not act upon or rely on information at this or any other website without the advice of competent counsel, especially if you reside outside the State of California, where I am not licensed to practice law and don’t give advice. Nothing provided by this website is intended to create an attorney-client relationship. Sending e-mail to this firm or to an attorney at this firm will not create an attorney-client relationship. This website is intended for educational and informational purposes only. Please read the full Disclaimer page to this site by clicking here.

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