The "Disappearing" Estate Tax
Congress has created an illusion worthy of Houdini.

Before it's all over,the elimination of the death tax may seem more of a Houdini-like illusion than a reality. With complicated increases in the amount of the exemption through the year 2009, then a 1-year elimination of the estate tax in 2010, and a reappearance in 2011, many estate planners are saying that all we need is a crystal ball to digest the new law. And that's if Congress doesn't enact further changes.

WHY IS IT SO COMPLICATED?

The Economic Growth and Tax Relief Reconciliation Act of 2001 presents a complex set of scenarios, depending on the date of the wealth transfer. Thanks to the uncertainty surrounding the following three questions, estate planning is now a perplexing task.

• How much wealth will be transferred from the estate?
• In what year will the wealth transfer through death occur?
• Will there be an estate tax at the time of the transfer?

The effect of the estate tax will be gradually reduced between 2002 and 2009. Then, according to the new law, there will be no estate tax due for decedents dying in the year 2010. However, if a person dies in 2011 or later, estate tax will be in full force because the law will revert to current law regarding the transfer of wealth. This is the so-called "sunset" provision.

None of the changes in the new law will stay in effect unless Congress re-enacts them and the President signs the legislation into law. Since it's impossible to know what the political and economic climate will be in 2011, estate planning should take into account the possibility that estate tax will be assessed on estates of as little as $1 million for those dying in 2011 or later.

• How much wealth can be transferred estate tax-free?
  Current law provides an exemption of up to $675,000 of property transferred at death. For decedents dying in 2002, $1 million of property may be transferred free of federal estate tax. The exemption amount will gradually increase. (In 2009, $3.5 million of property may be transferred free of federal estate tax.) But remember, in 2011, the exemption amount is due to revert back to $1 million unless Congress enacts additional estate tax relief legislation.
• Will estate tax rates change from 2002 through 2009?
  If a person owns assets totaling more than the exemption amounts noted above and dies between 2002 and 2009, the tax rates on the taxable estate (the assets greater than the exemption amount), will be gradually reduced from the top 55% rate in effect today to a top rate of 45% in 2009. In 2010, the estate tax rate will be 0%. However, in 2011, unless further legislation is enacted, the top rate will revert to the current 55% rate, and a 5% surcharge will apply to certain estates over $10 million.
• If the estate tax isn't in effect when I die, will my heirs pay income tax when they sell the estate's assets?
  According to the new law, if a person dies when no estate tax is in effect, the property acquired from the decedent will be treated as if it had been acquired by gift. No estate tax will be due, but a capital gains tax, based on the property's value when it was originally acquired, will be due at the time of the asset sale.
  Some transferred assets won't be subject to this capital gains tax. A transfer of up to $1.3 million in assets to a person other than the deceased's spouse will be valued at the increased date of death value (capital gains tax won't be due if the assets are sold for this amount). An additional $3 million of assets may be transferred to a spouse at the increased date of death value.

Because these rules are so complex, you should consult your financial advisor concerning your specific situation.

Richard J. Alphonso, JD, CPA/PFS, M.S.T., and Anita S. Frank, CPA, are president and tax manager respectively, of The Financial Advisory Group, Inc., in Houston. The Financial Advisory Group provides personalized fee-only financial planning, investment management and business consulting services.