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What's New For 2002?
by Robert L. Moshman
Estate Tax Changes
Inflation Adjustments
Tax Relief For Victims of Terrorism
t is a time of many uncertainties. After 10 years of economic expansion, the economy is officially in a recession of indeterminate length. Eleven interest rate cuts and plummeting gas prices have failed to stimulate the economy and forecasts of huge budget surpluses now seem wildly optimistic.
With tax revenues shrinking, Congress may once again see the merits of taxing wealthier estates. In fact, publications such as The Wall Street Journal have referred to the widely held belief that the estate tax repeal won't happen. It's less than a year since the law was enacted, yet it's as though a non-repeal is being taken for granted. Having once assumed (erroneously) that Congress would never repeal the estate tax, prudence alone dictates that nothing be taken for granted.
Yet, apart from such long-range handicapping of the ultimate treatment of the elite few estates that would remain subject to an estate tax, there are significant changes in the structure of the transfer tax system that will be implemented and which will have a profound effect on those estates that are currently subject to such tax.
For example, if Congress doesn't collect estate tax revenues from a majority of estates, states will quickly step into that void and claim revenues to make up for the phase out of the state death tax credit. States facing budget shortfalls may want to do more than make up for the loss of the state death tax credit. And regardless of what the states do, the Federal estate tax is changing in ways that affect planning right now.
Top rate to 50%
Elimination of 5% surtax
Unified credit to exemption equivalent of $1 million
Annual gift tax exclusion remains at $10,000
GST exclusion moves to $1,100,000
Conservation easement amount now $500,000 and rules for qualifying lands are relaxed
State death tax credit reduced by 25%
The top estate tax rate in 2001 had been 55% with an additional 5% surtax offsetting the benefit of the graduated tax rate schedule which applied to portions of estates between $10 million and $17,184,000. Under the Economic Growth and Tax Relief Reconciliation Act of 2001, the top estate and gift tax rate drops to 50% for 2002 and the 5% surtax has been eliminated altogether. The unified credit has also been increased, so the portion of an estate that can now be transferred free of estate tax has risen from $675,000 in 2001 to $1 million in 2002.
Note that 2002 and 2003 form a two-year period in which the estate tax will be relatively stable. During that time, the top rate will drop from 50% to 49% for 2003, but the size of the unified credit and other rules will remain unchanged. Note also that this period represents the last time the gift and estate taxes will be "unified."
After 2003, the credit will rise for estate tax purposes (then protecting $1.5 million of an estate). The GST tax exemption will also be equal to the estate tax applicable exemption after 2003 and will not be adjusted for inflation after that time. However, the $1-million credit will remain in effect for gift tax purposes.
The next major change in estate taxation will occur in 2004. The increase in the exemption amount for estate tax purposes in 2004 will significantly reduce estate tax liabilities in 2004. For example, the chart below indicates that an estate of $2 million could expect estate tax liability in 2002 or 2003 of $425,000 while the same estate would incur liability of $235,000 in 2004.
Related Changes
Under current law, the maximum state death tax credit is $1,082,800 plus 16% of the excess over $10,040,000. The phasing out of the state death tax credit commences in 2002 with a 25% reduction. Thus, if the adjusted taxable estate is over $10,040,000 for 2002, the maximum state death tax credit will be $812,100 plus 12% of the excess over $10,040,000. Next year, the maximum credit will drop to $541,400 plus 8% of the excess over $10,040,000 (a 50% reduction).
Conservation easements had their rules liberalized with the elimination of the requirement that property be within 25 miles of a metropolitan area, a wilderness area, or a national park. Under §2031(c)(3), the exclusion limitation rose from $400,000 in 2001 to $500,000 in 2002. This exclusion amount is now fully phased in and will remain at $500,000.
Inflation Adjustments
Cost of living changes affect many provisions this year. The following changes for 2002 were reported in Revenue Procedure 2001-59, December 26, 2001.
Expatriation: For calendar year 2002 the thresholds used under §877(a)(2), regarding whether an individual's loss of United States citizenship had the avoidance of United States taxes as one of its principal purposes, are more than $120,000 for "average annual net income tax" and $599,000 or more for "net worth."
Special-Use Valuation: For an estate of a decedent dying during 2002 if the executor elects to use the special-use valuation method under §2032A for qualified real property, the aggregate decrease in the value of qualified real property resulting from electing to use §2032A that is taken into account for purposes of the estate tax may not exceed $820,000.
Annual Gift Tax Exclusion: For calendar year 2002 the first $11,000 of gifts to any person (other than gifts of future interests in property) are not included in the total amount of taxable gifts under §2503 made during that year.
Non-citizen Spouses: During 2002, the first $110,000 of gifts to a spouse who is not a citizen of the United States (other than gifts of future interests in property) are not included in the total amount of taxable gifts under §§2503 and 2523(i)(2) made during that year.
GST Exemption: For calendar year 2000 the generation-skipping transfer tax exemption under §2631 , which is allowed in determining the "inclusion ratio" defined in §2642 , rises from $1,060,000 to $1,100,000. After 2003, the GST exemption will follow the estate tax exemption amount without further inflation adjustments.
Installment Payments: The dollar amount used to determine the "two-percent portion" (for purposes of calculating interest under §6601(j)) is $1,100,000.
Attorney Fees: Attorney fee awards under §7430(c)(1)(B)(iii) will now be limited to $150 per hour.
Luxury Tax: For calendar year 2002 the excise tax on luxury cars under §§4001 and 4003 is imposed on the first retail sale of a passenger vehicle (including certain parts or accessories installed within six months of the date after the vehicle was first placed in service), to the extent the price exceeds $40,000.
The Estate Tax Phased Out
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YEAR
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TOP RATE
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EXEMPT AMOUNT
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2001
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55%
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$675,000
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2002
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50%
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$1 million
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2003
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49%
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$1 million
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2004
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48%
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$1.5 million
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2005
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47%
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$1.5 million
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2006
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46%
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$2 million
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2007
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45%
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$2 million
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2008
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45%
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$2 million
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2009
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45%
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$3.5 million
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2010
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0%
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n/a
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2011
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55%
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$1 million
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Federal Estate Tax Consequences
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ESTATE SIZE
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2001
|
2002
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2003
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2004
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2005
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2006
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2007
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2008
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2009
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2010
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2011
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|
$675,000 (or less)
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$0
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$0
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$0
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$0
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$0
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$0
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$0
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$0
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$0
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$0
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$0
|
|
$1
million
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$125,000
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$0
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$0
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$0
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$0
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$0
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$0
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$0
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$0
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$0
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$0
|
|
$2
million
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$560,250
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$435,000
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$435,000
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$225,000
|
$225,000
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$0
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$0
|
$0
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$0
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$0
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$435,000
|
|
$3
million
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$1,070,250
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$930,000
|
$925,000
|
$705,000
|
$695,000
|
$460,000
|
$450,000
|
$450,000
|
$0
|
$0
|
$945,0000
|
|
$4
million
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$1,620,250
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$1,430,000
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$1,415,000
|
$1,185,000
|
$1,165,000
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$920,000
|
$900,000
|
$900,000
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$225,000
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$0
|
$1,495,000
|
|
$5
million
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$2,170,250
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$1,930,000
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$1,905,000
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$1,665,000
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$1,635,000
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$1,380,000
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$1,350,000
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$1,350,000
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$675,000
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$0
|
$2,045,000
|
|
$10
million
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$4,920,250
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$4,430,000
|
$4,355,000
|
$4,065,000
|
$3,985,000
|
$3,680,000
|
$3,600,000
|
$3,600,000
|
$2,925,000
|
$0
|
$4,795,000
|
Tax Relief For Victims of Terrorism
"We remember the cruelty of the murderers and the pain and anguish of the murdered. Every one of the innocents who died on September the 11th was the most important person on earth to somebody. Every death extinguished a world." -Remarks by President George W. Bush, December 11, 2001.
As we go to press, Congress passed the Victims of Terrorism Tax Relief Bill of 2001 (H.R. 2884), which is expected to be signed by the President in January. This bill had previously been part of an economic stimulus package but ended up standing alone. It covers not only victims of the September 11 terrorism but also those affected by anthrax attacks and the 1995 bombing in Oklahoma City.
The bill treats individuals who died as a result of the terrorist attacks that occurred on September 11, 2001, or April 19, 1995, or as a result of illness incurred due to a terrorist attack involving anthrax that occurred on or after September 11, 2001, and before January 1, 2002, in the same manner as if they were active members of the U.S. Armed Forces killed in action while serving in a combat zone or dying as a result of wounds or injury suffered while serving in a combat zone for purposes of §2201.
Under present law, §2201 limits the Federal estate tax liability to 125% of the maximum State death tax credit determined under §2011(b). As revised by the new bill, §2201 first $8.5 million of a victim's assets would be free of Federal estate tax and the first $3 million would be free from State estate tax.
Under the new law, victims will not be liable for Federal income tax for the year of their death or the year prior to their death. There are numerous precedents for these tax relief gestures that reflect a 35-year overview of our nation's armed conflicts and international incidents.
Background
There are numerous precedents for these tax-relief gestures that reflect a 35-year overview of our nation's armed conflicts and international incidents.
Tax relief was extended to crew members of the U.S.S. Pueblo who died while being illegally detained by North Korea in 1968. Tax relief was extended to American civilians held hostage by Iran in 1980. In 1984, following events in Grenada and Lebanon, legislation extended tax relief to U.S. military and civilian personnel for injuries or wounds that were incurred in a terrorist or military action.
Congress passed additional legislation in 1990 after the Lockerbie, Scotland, plane crash, in 1991 after Operation Desert Shield, and in 1996 during Operation Joint Endeavor in Bosnia and Herzegovina, Croatia, and Macedonia.
In 1997, Congress empowered the Secretary of the Treasury to provide procedural tax benefits under §7508A, i.e., extending the time for payment of taxes or performing other acts by up to 90 days for Presidentially declared disasters. This time period was extended to 120 days by legislation in 2001. The newest tax relief law expands §7508A to permit the Secretary to suspend the period of time for payment or performing various acts for one year (as opposed to 120 days).
Costs: The price tag for the latest tax relief efforts is expected to be $190 million in 2002, $151 million of which is related to income tax relief. Exclusion of death benefits will cost about $25 million and the estate tax provisions will amount to about $3 million in lost revenues. However, the total costs will add up to $313 million by 2006, with $57 million attributable to the reduction in estate tax revenues.
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