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Tax Law 2001 Memo: Federal-estate tax only

The federal estate tax will phase-out gradually.  The unified credit or the amount that an individual may pass free of estate or gift tax (either at death or during life) will be:

Year                Top Estate Tax Rate             Exemption Amount

2002                            50%                                    $1,000,000

2003                            49%                                    $1,000,000

2004                            48%                                    $1,500,000

2005                            47%                                    $1,500,000

2006                            46%                                    $2,000,000

2007                            45%                                    $2,000,000

2008                            45%                                    $2,000,000

2009                            45%                                    $3,500,000

2010                            repealed                                   N/A

2011                            55%                                    $1,000,000

There is a full repeal of the estate tax in 2010.  Simultaneously the plan reduces the top estate and gift tax rates gradually over the same period from 50% to 45%.  However, the full repeal is only in effect for the year 2010.  In 2011, the bill provides for an automatic reinstatement of the 2001 estate tax rules.  Tax experts disagree on whether the tax will be revived and if so, to what extent.

Upon full repeal of the estate tax, the law will replace the current stepped-up basis on assets given at death with carry over basis.  This will require heirs to keep track of the original basis.  The law does allow $1.3 million of basis to step up for some assets and $3 million to step up with regard to assets transferred to a surviving spouse.  This provision excludes property acquired by a decedent by gift from a non-spouse within three years prior to decedent’s death.

The law retains the gift tax, in part to prevent the use of gifts to transfer property from higher to lower rate taxpayers.  Upon repeal of the estate tax the maximum gift tax rate will be 35% with a lifetime gift exclusion rising to $1 million in 2002 and remaining at the said $1,000,000.  The current annual exclusion is $12,000 per individual (adjusted for inflation).  After 2010, transfers to a trust will be a taxable gift unless all of the trust’s income is taxed to the donor or the donor’s spouse.

The state death tax credit that had previously been allowed against the federal estate tax has been phased out as well.  The law reduced the credit by 25% in 2002, 50% in 2003, and 75% in 2004.  As of 2005, the credit was repealed and replaced by a deduction against the federal estate tax in place of the credit for the state death taxes paid.  It was estimated [1] that this will result in a loss of $50-$100 billion to the states over the 10 years following the change, or approximately 1.5% of states tax collection.

The estate tax changes are difficult for “planning”.  Revisions to wills and trusts and/or the funding of the typical revocable trust will be necessary on an ongoing basis.  Full repeal of the estate tax will occur only for one (1) year, 2010.  The automatic reinstatement of the 2001 rules in 2011 will undoubtedly force Congress to revisit this issue again, although a recent attempt to get a permanent repeal through Congress failed.


  • Availability of qualified conservation easements to remove requirements for proximity to national parks, wilderness areas, and non-urban areas are expanded.
  • The generation-skipping transfer tax rules are also modified.

[1] New York Times article dated June 21, 2001

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