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Rethinking Estate Planning

A shorthand way to define "estate planning" is that it's the decisions you make about who in your family or elsewhere should get which and how much of your assets after, or in contemplation of, your death. The stimulus for planning an estate is the prospect of the federal estate tax and the wish to avoid or reduce it.

Whatever else the 2001 Tax Relief Act may have done to the estate tax — and it was a lot — it did not remove the need for estate tax planning as many taxpayers have been led to believe. For one thing, the alleged estate tax "repeal" is put off for almost a decade. Then, the repeal is for the year 2010 only. After that, the estate tax is revived under a sunset provision as if the 2001 Act had never happened, meaning that true repeal (lasting beyond 2010) must be enacted by this or another Congress — and President.

In the interim, a number of 2001 Act changes go into effect from 2002 to 2009. For taxpayers who haven't yet begun their estate tax planning, the biggest change is in which estates are taxed. Specifically, an estate tax only applies to estates where, aside from amounts passing to surviving spouse or charity, where a taxpayer's estate in 2002 is $1 million or more (up from $675,000 in 2001). This $1 million exemption is called the "unified credit" and rises periodically after 2002 and eventually to $3.5 million in 2009. It's called "unified" because it's paired with a credit for lifetime gifts; Gifts counted against the credit are in effect part of your taxable estate (so that an estate tax could apply in 2002 even though assets in your hands at death are less than $1 million). The gift tax exemption rises to $1 million in 2002 and stays there, although the gift tax rate drops to 35% by 2010.

Those who have already begun estate tax planning must revisit their existing estate plan. Revisions may be needed:

· Where lifetime gifts are involved. Excludable gifts — up to $10,000 (actually, this is now $11,000 in 2002 and eventually rises to $15,000 annually) per donee per year — should continue, assuming they are gifts of present interests. These don't count against the credit. Gifts against the credit can now go up to a lifetime ceiling of $1 million. But making taxable gifts (in excess of the credit), which is part of some individuals’ estate plans, should probably be changed: they incur what may be an "unnecessary" tax, a tax which the new estate tax law repealed.

· Today's special deduction for family business interests is repealed after 2003. This wouldn't increase estate tax over what it would be today, but would reduce the benefit from holding assets in this form.

· Formula clauses. These may contemplate a certain distribution of assets based on the unified credit, and should be revisited to reflect changing credit amounts. Many clauses of estate planning documents should now be written on an "if...then·" basis, to be activated according to the rules that may be in effect in specific years of death. It may also be important for the plan to include grants of powers of attorney to be activated should the taxpayer become unable to act in a changed estate tax situation.

· Generation-skipping tax. The exemption from this tax rises with the estate tax exemption (unified credit), which will encourage more transfers that in effect skip a generation.

· Under today's law, unrealized gain in an asset included in an estate escapes income (capital gains) tax in the heirs' hands due to the step-up in basis rule. Part of the estate tax repeal would also exempt some of this gain and tax the rest (when inherited assets are sold). Planning in contemplation for estate tax repeal would allow planning for allocating this exemption.

· State transfer (death) taxes. All states have these. Some states have special tax systems, such as inheritance taxes. Estate planning has always involved needing to plan for such taxes, which can apply even where no federal tax is due. States also have an estate tax system built around the federal credit for state tax. The 2001 Act replaces this credit with a deduction after 2004, a move which affects estate planning differently in different states. In some states, the resulting federal deduction (rather than credit) will tend to increase the federal tax due. In others, state estate tax would disappear (absent state action) with no tax effect on the estate.

In summary, it would be best to rethink your planning for your estate immediately. Otherwise, tens of thousands of dollars may be sent to federal and/or state governments instead of your heirs.

For further information, contact Diane M. Pearson, CFP™ at (412) 635-9210 or

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