The Economic Growth and Tax Relief Reconciliation Act of 2001 (“2001 Tax Act”) was passed by Congress and signed by President Bush on June 7, 2001. The 2001 Tax Act greatly affects estate and gift tax planning, but it does not, as commonly reported, repeal the estate tax for any appreciable length of time. That said, there are several provisions in the 2001 Tax Act that will prove to be of benefit, often substantial, to taxpayers. The most immediate benefit is the increase in the federal estate, gift and generation-skipping tax Unified Credit to $1 million per person in the year 2002, along with a reduction in the top estate (and generation-skipping) tax rate to fifty percent (50%). While the estate and generation-skipping tax Unified Credit increases each year after 2002, the gift tax Unified Credit remains at $1 million per person. Until January 1, 2010, the 2001 Tax Act reduces the top estate, gift and generation-skipping tax rates and increases the Unified Credit as set forth on the following table:

In its most public, and perhaps most misunderstood provision, the 2001 Tax Act also repeals the estate and generation-skipping taxes (but not the gift tax) imposed on estates of decedents dying after December 31, 2009. The “cost” of this repeal is that the decedent’s basis in assets will no longer be increased to fair market value at the date of death. Rather, a carryover basis system, with certain exceptions, will cause the heirs of the decedent to take the decedent’s assets at the basis that the assets carried in the hands of the decedent at the time of his or her death. This will generally result in a capital gains tax to the heirs when the assets are sold. Two facts about this repeal of the estate and generation-skipping taxes are either misrepresented or not divulged in media reports. First, while the estate and generation-skipping taxes disappear for the year 2010, the gift tax imposed on transfers during lifetime will remain in effect and will be imposed on lifetime transfers in excess of $1 million. The gift tax rate will equal the highest income tax rate, which at this time is scheduled to be 35%. Second, although the estate and generation-skipping tax repeal takes effect in 2010, due to a bizarre provision in the law, the current estate and generation-skipping taxes (including the current rates) are reinstated on January 1, 2011, along with a reinstatement of the “step-up” in basis provisions. Therefore, while, as represented, there will be a repeal of the estate and generation-skipping taxes, that repeal will last only for one year! This leaves open the crucial question as to whether the estate and generation skipping taxes will actually be repealed in the year 2010. This uncertainty results from the fact that between now and the year 2010, there will be four Congressional and two Presidential elections. There are also still a number of issues, philosophical, political and economic with respect to the proposed repeal structure, driven mostly by the federal government’s need for revenue and the sources of such revenue.

All of the above is a rather long-winded way of saying that there has been much uncertainty interjected into the estate planning process long term. There might or might not be a repeal of the death tax in 2010. It is clear, however, that estate, gift and generation-skipping tax planning remain important (perhaps even more so) for everyone between now and 2010 and from 2011 on.

We advise a current review of all estate plans, particularly those that are fashioned in such a manner as to allow the use of the Unified Credit of the first spouse to die. These plans were established under the assumption that the maximum Unified Credit amount funding the Family Trust-Unified Credit Share would be $1 million, but not until the year 2006. Under the 2001 Tax Act, the Unified Credit per person now increases to $1 million next year, $1.5 million in the year 2004, $2 million in the year 2006 and $3.5 million in the year 2009. The vast majority of estate planning documents with this type of a plan rely on a formula provision to divide the estate or trust assets between the Family Trust-Unified Credit Share and the Marital Share without reference to a specific dollar amount. The use of this formula in light of the rapid increase in the Unified Credit may produce an imbalance of assets allocated to the Family Trust and surviving spouse. If more assets than intended are allocated to the Family Trust-Unified Credit Share, the Marital Share or the share of the estate intended for the use of the surviving spouse alone may not receive enough assets to enable the surviving spouse to feel secure in his or her financial position. Also for very large estates, even if the continuing use of a formula provision to divide estate or trust assets between the two shares remains appropriate, asset ownership between spouses must be reviewed and perhaps altered to ensure the maximum use of the Unified Credit by the estate of the first spouse to die. An additional effect of the 2001 Tax Act is that some tax plans may be simplified given the increase in the Unified Credit.

We would be delighted to discuss the impact of these tax law changes on your personal estate plan with you at any time. We presume that you will want to review your planning soon. As always, we are ready to assist you in whatever way possible.

If you have questions about the 2001 Tax Act, please feel free to contact either Jim Preston in the Charlotte office of Parker Poe at (704) 372-9000.

This Alert is a general review of the subjects covered and is not legal advice.