Alert: What Does the Estate Tax "Repeal" Mean for You?

June 01, 2001

The Economic Growth and Tax Relief Reconciliation Act of 2001 repeals the estate and generation-skipping transfer (GST) taxes but not until 2010. Beginning in 2002 and through 2009, the estate and gift tax rates will be reduced and the lifetime exemption from estate tax will be increased. In 2002, the lifetime exemption from estate tax will be $1 million per person. The exemption will increase to $3.5 million in the year 2009. The exemption for gifts made during lifetime will increase to $1 million per donor in 2002 as well, but that amount will not increase over time.

One of the greatest sources of confusion about the new tax law is that the estate tax is actually only repealed for one year, 2010. In 2011, the repeal will expire and the estate tax will return unless a new law is passed to extend the repeal.

Even if repeal occurs in 2010 and becomes permanent, the government will switch to taxing the capital gains on estate assets, meaning that heirs will have to be able to show how much someone paid for an asset years ago.

The good news for our clients is that although we recommend that every estate plan be reviewed every year or two, our documents include a formula clause which provides flexibility to take advantage of the increases in the lifetime exemptions from estate tax. As the exemptions increase, the formula we use in our clients' wills and trusts ensures that the higher exemption amounts will be utilized without the need for any changes. Therefore, it is unnecessary for otherwise up-to-date wills and revocable trusts to be revised simply based on this newest change in the law.

Given the changes in the law and the increase in the lifetime exemption which goes up to $1,000,000 as early as 2002, we recommend that our clients consider making gifts to their heirs early next year, either outright or in trust. It makes sense to take immediate advantage of the increases in the lifetime exemption as there is no guarantee that the law as it is currently written will remain in effect.

In addition, it is important to recognize that even without the estate tax, there are many non-estate tax considerations that will remain critically important to our clients in planning their estates.

Revocable Living Trusts

Revocable Living Trusts (RLT) will continue to be an important estate planning vehicle. RLTs provide several benefits. First and foremost, they avoid probate. They also afford greater privacy than a will about the nature of the dispositions made and the identify of the beneficiaries. Another major advantage of a RLT, if funded during lifetime, is the ability to manage property in the event of incapacity. Even though a durable power of attorney is helpful, a revocable trust offers more assurance that the property will be easily managed by the successor trustee.

Use of Trusts for Other Reasons

Using a trust provides many benefits. Commonly, a trust is used when the beneficiary is a minor or is incapacitated. In some cases, the beneficiary has a poor track record with investments and the trustor believes it would be unwise to give him or her the management of the assets. In other cases, the trustor may believe that the assets are so great that professional management is required. Trusts also prevent beneficiaries from recklessly spending all of their wealth. A trust can provide a system of checks and balances.

Asset Protection

A spendthrift clause is an important part of estate planning. A spendthrift clause in a trust provides that a beneficiary's interest in the trust is not subject to voluntary or involuntary transfer and is not subject to enforcement of a money judgment. A major area of concern for clients is protection of assets in the event of divorce. A trust can be set up by parents for adult children, which will provide protection in the event that the child goes through a divorce. If the assets are titled directly in the child's name they may be considered by the court in determining the proper amount of spousal support even if they are the child's separate property. If the assets are held in trust, the court is less likely to consider them "available" for spousal support purposes, especially if there is a spendthrift provision in the trust.

Charitable Remainder Trusts

Charitable Remainder Trusts (CRTs) should continue to be a popular planning method for many clients. A CRT makes payments to one or more individuals for their lives or for a period of time, with the remainder passing to charity. Creating a CRT provides a charitable income tax deduction equal to the present value of the remainder interest that will eventually go to charity. Because charitable remainder trusts are also exempt from income tax, they are used to improve cash flow and reduce taxable income for the income beneficiaries who are usually the grantor and the grantor's spouse. This is how they usually work: appreciated assets are transferred to the trust and then sold by the trustee, leaving the entire proceeds available for reinvestment for the benefit of the income beneficiaries. The sale of the appreciated assets avoids capital gains because the CRT is exempt from income tax.

For more information on estate planning matters, please contact Family Wealth & Business Planning attorneys:

R. Frederick Caspersen
415.954.4427
fcaspersen@fbm.com

Lara N. Gilman
415.954.4913
lgilman@fbm.com

Michael L. Korbholz
415.954.4956
mkorbholz@fbm.com