Senior Lawyer News

Comments on the new Tax Act

Tax Planning: Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") in June. Detailed information and analysis of EGTRRA is available on many Web sites, as well as in many publications. These comments point out several issues that the Act has created, with some suggested steps to alleviate possible unexpected impact on your personal tax situation.

Sunset Provisions: Absent further Congressional action, all changes made under the Act will vanish after December 31, 2010. As of January 1, 2011, individual income tax rates will increase to their pre-enactment level. The estate tax and the generation skipping transfer tax will go back into effect, and the unified credit will allow the transfer of $1 million free of transfer tax (either estate tax or gift tax). The changes allowing tax free distribution and other tax-favored treatment of education savings plans will disappear, and provisions in the Act allowing increased contributions to retirement plans and IRA's will revert to current levels and limitations.

Complexity: The sunset provisions by themselves create uncertainty and make it difficult to plan effectively. In addition, the estate tax provisions are particularly complex. Many commentators say that the estate tax repeal as now drafted is broken and will be fixed. But no one knows if, how or when this will happen, creating even more uncertainty. Here are some interim suggestions:

Make lifetime gifts to utilize the full amount that can be transferred free of gift tax. The gift tax, unlike the estate tax, is not scheduled to go away, and the amount that can be transferred free of gift tax is limited to $675,000 in 2001 and $1 million in 2002 and thereafter. Passing appreciation to younger generations usually makes sense, and one is never sure that repealed taxes will not be reenacted in the future.

Do not make taxable gifts that will require payment of gift taxes. If the estate tax is repealed permanently, that gift tax will have been paid unnecessarily.

Utilize leveraging techniques and valuation discounts for those gifts whenever available. Grantor Retained Annuity Trusts, Charitable Lead Trusts, Family Unlimited Partnerships (or limited liability companies), sales to defective grantor trusts and similar techniques remain viable planning tools. Gifts of property with appreciation potential (such as stock in a start-up company) also make sense.

Review wills and revocable trust documents to make sure that you do not inadvertently reduce the amount of passing to your spouse. Many wills and trusts provide for a Family Trust, funded by a formula tied to the amount that can pass free of estate tax. Under the new law, that formula might increase that amount to be allocated to the Family Trust, thereby reducing or even eliminating the amount that would pass to the surviving spouse. Since the Family Trust often provides for distributions to multiple family members, the surviving spouse may receive less than the decedent intended. In the worse case scenario, the surviving spouse may be disinherited altogether if descendants were the sole beneficiaries of the Family Trust.

Track basis in assets. When the estate tax is repealed in 2010, the stepped-up basis is also repealed (with certain limited exceptions). Therefore, it is important to track the basis of all assets, even those that you expect not to sell during your lifetime. Incomplete records could result in your heirs having to pay substantial capital gains taxes that would not be due if they could substantiate basis.

Maintain life insurance policies. Since repeal of estate taxes does not occur until 2010 and is not guaranteed to be permanent, the need for life insurance may continue. If the need arises at a later date, you may not be insurable or the cost may be substantially higher. At the same time, however, you may consider borrowing against the policy to pay premiums or even in some circumstances to invest.

Consider making gifts to education savings plans for children, grandchildren, nieces and nephews. The education savings plans offered under Section 529 offer tax free growth and distributions (at least until 2010) for educational purposes.

EGTRRA did not enact a provision dealing with contributions of IRA's to charity during life. However, new rules (independent of EGTRRA) affecting IRA distributions make it easier to designate a charity as one of the beneficiaries of an IRA, and a bill is presently in Congress to allow rollovers of IRA's to charity.

Anne B. Shumadine

Signature Financial Management

Norfolk, VA

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