What Estate Tax Repeal Means For Most Taxpayers: Not Much

JUNE 11, 2001 VOLUME 8, NUMBER 50

On June 7, 2001, President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001. Despite extensive media coverage of tax reform, and especially of estate tax repeal, over the past six months, you may have been left wondering what it means. It turns out that it doesn’t mean much for most of us.

Estate tax repeal will have one of two effects for most people. For some, the change in tax laws will mean they must spend more on lawyer’s fees for changes to their estate plans—and may have to make more than one set of changes as the rules slowly shift over the next decade. For most people, however, the principal effect of estate tax repeal will be felt when government revenue must be raised from some other source—possibly including taxes on middle class citizens who wouldn’t have paid estate taxes under the old rules.

There are four elements of estate tax repeal that make it difficult to predict exactly what will happen over upcoming months and years:

Reductions in the estate tax will be phased in over a ten-year period, with relatively little change before full repeal. The current $675,000 exemption from federal estate tax liability is raised to $1 million next year and then increases slowly, but it only reaches $3.5 million before repeal.
The top tax rate drops slightly each year, from the current 55% to 45% in the year before the tax is finally eliminated.
Upon repeal of the estate tax, a new system of taxation is imposed—heirs will pay income taxes on capital gains when they sell inherited property. There will, however, be a substantial exclusion from this new tax—$1,300,000 of gain for every decedent’s estate, and another $3,000,000 of gain for surviving spouses.
Estate tax repeal is itself repealed in 2011.

That’s right: as currently written, the law ending the estate tax in 2010 ends (and the estate tax returns) in 2011. Authors of the tax repeal measure insist that they only included that provision in order to “balance” the budget for the next decade, but real estate tax repeal will require another Congress and President to sign another bill sometime in the next decade.

The new law eventually eliminates the “generation-skipping” tax, which penalized transfers to grandchildren (although a $1 million exemption makes the penalty less onerous). The gift tax, however, remains in effect—to keep taxpayers from giving their property to terminally ill family members expecting to get the property back within a few years.

Meanwhile, no one dares predict how federal estate tax “repeal” will affect state governments, where the estate tax has been a major source of revenue for decades. Arizona, for example, received about $80 million from the state estate tax last year. The federal credit for payment of state taxes will be phased out starting in 2002, so that the effect of estate tax reductions will be smaller—unless states follow the federal governments’ lead.

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