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Estate Tax exemptions rise

Posted: Wednesday, January 16, 2002

WASHINGTON (AP) -- Estate tax exemptions rise and the top tax rate falls in 2002 as the tax begins its long march to repeal at the beginning of 2010 -- a situation that opens up a whole new set of problems.

The 10-year, $1.35 trillion tax cut enacted last year will gradually phase out the estate or ''death'' tax over the next decade while increasing the amount exempt from tax. In 2002, the top tax rate falls from 55 percent to 50 percent and the per-person exemption rises from $675,000 to $1 million; a couple can exempt $2 million with minimal estate planning.

Looking ahead, the new tax law scraps the estate tax on Jan. 1, 2010. Before repeal, the top tax rate drops only to 45 percent but the exempt amount rises to $3.5 million.

But because of a Senate budget rule, the law ending the tax expires exactly a year later, on Jan. 1, 2011.

That means unless Congress makes the tax cut permanent, the estate tax will reappear as it was in 2001. It also means that people who expect to have taxable estates have some choices to make, based on what they believe might happen in the future.

Most estate planners say it's wise to assume some inheritance tax will be in place, no matter when you die. Many believe that Congress will keep the higher exemptions in place to protect farmers and small businesses but will eventually reinstate an estate tax.

''It's hard to imagine that the federal government is going to allow a large amount of wealth to pass through generations without them taking a piece of it,'' said Don Weigandt, vice president for wealth advisory at J.P. Morgan Private Bank in Los Angeles.

A case in point: President Reagan's 1981 tax cut reduced the top estate tax rate from 70 percent to 50 percent over four years. After three years, the top rate fell to 55 percent as scheduled but Congress froze it there because revenue needs had changed -- just as deficits now are replacing surpluses in Washington.

Assuming the tax remains, Weigandt said there are several strategies to consider. The most common one is to give money away during lifetime to reduce the taxable estate left at the end.

''If you want to save on estate taxes, you need to die with less assets,'' he said. ''It's kind of tough to time your last expenditure to your last breath, so it's better to give assets away during your lifetime.''

An individual can give up to $11,000 away each year to an unlimited number of people without incurring gift taxes, an increase because of an inflation adjustment from the $10,000 previous limit. There is no limit on gifts to a spouse.

The lifetime gift tax exemption for gifts exceeding these limits is $1 million -- an increase of $325,000 over last year that remains the new permanent cap.

There are a number of trusts and partnerships involving children that can reduce the amount of taxable assets. For example, a ''freeze'' strategy involves selling an appreciating asset to the kids for an installment note with a reasonable interest, which effectively shifts the bulk of the profit to children without exposing it to estate tax.

As time goes on, adjustments might be needed to such arrangements as the tax-exempt amount rises from $1 million to $3.5 million. In some situations, the children might wind up with the full inheritance while the spouse gets nothing, or vice versa.

Another thing to consider is the change in capital gains taxes that accompanies repeal of the estate tax in 2010.

Beginning then, heirs can be held liable for taxes on all of the capital gains associated with an asset from the time the decedent purchased it. Under current law, heirs pay capital gains taxes only on the appreciation of the asset from the date the owner died to when the heirs sell it.

Bottom line: An heir in 2010 could face a much bigger capital gains tax bill on any inherited assets that are sold.

There is some relief, however. Executors of estates will be able to increase the basis of assets in the estate by up to $1.3 million, with another $3 million available for spouse inheritances.



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