This is the fourth of a series of articles that will summarize the Economic Growth and Tax Relief Reconciliation Act of 2001 that was approved by Congress over the Memorial Day weekend and signed by President Bush on June 8. This legislation, which will be phased in over a 10-year time frame, provides significant and varied tax reductions to individuals.

One of the more complex tax changes deals with estate tax. Over the next 8 years, the estate tax will be gradually phased out, until it is completely repealed in 2010. However, in 2011, the estate tax rules that were in force prior to the tax law change are again reinstated.

Confused? You are not alone.

Gift Tax/Estate Tax

Many years ago, the Gift and Estate Tax sections of the tax law were coupled. The primary purpose of the legislation was to impose a tax on individuals at the time they disposed of their assets. Thus, if while they were alive an individual made a gift of more than $10,000 (to someone other than their spouse), the tax law imposed a gift tax on the person giving the gift. The tax ranged from 18% to 55% of the value of the gift.

When that individual died, the law imposed a tax on the fair market value of their estate. The tax ranged from 18% to 55% of the fair market value of the estate.

The law did allow for $675,000 to be exempt from either gift or estate tax. However, the $675,000 was a cumulative amount to be used during the life of the individual. As an example, suppose an individual made a birthday gift of $110,000 to a nephew. The first $10,000 of the gift falls under the annual $10,000 exclusion. The individual can than use $100,000 of their $675,000 lifetime exclusion to avoid tax on the remaining $100,000. The individual would than have a $575,000 exclusion available to offset future gifts or to reduce the fair market value of the estate.

Phase Out Schedule

The estate tax will be phased out by both reducing the top estate tax rate each year, and by increasing the exemption amount, as follows:

Basis of Assets Received From A Decedent In 2011

Under the old law, assets received from a decedent had a basis equal to the fair market value on date of death. For example, if an uncle purchases 100 shares of stock for $1,500, and that stock was worth $10,000 on the date of your uncle’s death, and the stock was left to a nephew, the nephew’s basis for determining gain or loss on the sale of the stock was $10,000.

Under the new law, the nephew’s basis will be $1,500. Hence, assets that remain in a family over several generations will require extensive record keeping.

Gift Tax

While the estate tax has been repealed, the gift tax has not. The increasing exemption over the next 7 years creates an opportunity to transfer assets from high to lower rate individuals.

The window of opportunity for gift giving will close after December 31, 2009. Starting in 2010, gifts in excess of the $1,000,000 lifetime exemption will be subject to a 55% tax rate.

Summary

As the tax cut legislation was driven by politics, and not economics, tax planning should be completed while the tax laws are effective. In 4 years, all of the tax cuts made by the June legislation could disappear. The prudent individual will not postpone their tax planning.

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the President of ETS Ltd. Questions should be sent to: jsabo@expatriatetaxservices.com.