Decker & Associates, Inc. | Financial Advantage Newsletter

On June 7, 2001, President George W. Bush signed The Economic Growth & Tax Relief Reconciliation Act of 2001. This law temporarily changed estate taxes for everyone who dies after January 1, 2002 and brings back income taxes on assets passed to heirs. In this article we examine two important aspects of the new law - temporary estate tax relief and the income tax implications.

The new law introduces new estate tax limits starting in 2002 with an ultimate repeal of all estate taxes in 2010. However, just a year later, in 2011, we return to the current estate tax law that permits everyone to leave $1,000,000 free of tax.

What does this mean for you? If you die and your estate is less than the following amounts, your heirs will not pay estate tax:

Year	Estate Tax Exemption
2001	$675,000
2002	$1,000,000
2003	$1,000,000
2004	$1,500,000
2005	$1,500,000
2006	$2,000,000
2007	$2,000,000
2008	$2,000,000
2009	$3,500,000
2010	Tax Repealed
2011	$1,000,000

For example, Susan is a single US citizen with a net worth is $600,000. If she died in 2002 with life insurance of $300,000, her estate would be $900,000. Her heirs will not owe estate tax since her estate is less than $1,000,000.

With proper estate planning, a married couple will be able to leave their heirs, free of estate tax, two times the exemption amount.

Additionally, the maximum estate tax rate has also been reduced. The maximum rate, like the estate tax exemption, is based upon the year of death. The following maximum rates apply:

Let's assume that Susan miraculously recovers, the stock market recovers and her net worth climbs to $5,000,000 in 2009. She decides to give you $1,000,000 but on her way to the bank to transfer the funds, she is run over by a motorcycle and dies. That $1,000,000 in her estate will be taxed at the maximum rate of 45%.

You may say, "Well that's not too bad. She can pass $3,500,000 without estate tax." But wait, there's more � with the new law, there is also an income tax impact.

Under the prior law, in effect to January 1, 2002, if a person bought an asset for $X and it appreciated to $Y by the time of his death, the asset would be valued at $Y in the estate. When the heirs sold the asset, $Y was the basis for determining the gain subject to income tax.

Let's assume that Susan had a stock portfolio with an income tax basis of $10,000. It appreciated to $500,000 by the time of her death. Her heirs owe no estate tax, but when they sell the stock, the difference between the selling price and $10,000 could be subject to income tax of 20%.

Had she died before 2010, she may have owed some estate tax, but the assets would have been revalued at the $500,000 value at the date of death and only appreciation after death would be income taxed.

Under the new law, after 2010, the executor will be able to "shelter" $1,300,000 of appreciation of qualified property. This may seem like a reasonable amount for now, but with a simple 10% return, a $500,000 portfolio today would be worth over $3,000,000 by 2020. The gain, subject to income tax would be $1,200,000 ($3,000,000 less $500,000 basis less $1,300,000 shelter). The income tax would be 18% of $1,200,000 or almost $240,000.

In the past, planners primarily focused on making certain there was adequate liquidity to pay estate tax. Now we have to be concerned with income tax on estates of any size and detailed record keeping of adjustments to basis.

It is important that you realize that the estate tax laws are very complex. We want to call your attention to the need for planning that you should be doing in these times of changing laws. Should you have any questions or comments, please send them to lorraine@deckerusa.com.