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Estate and Gift Taxes
By
Robert
E. McKenzie
¶ 101. Increase in unified credit
Prior to 1998 a unified estate and gift tax
credit of $192,800 effectively exempted the first $600,000 of cumulative
transfers. Beginning in '98, the effective exemption is gradually being
increased until it reaches $1,000,000 in 2006. The unified credit will provide
an effective exemption of $625,000 for decedents dying, and gifts made, in '98;
$650,000 in '99; $675,000 in 2000 and 2001; $700,000 in 2002 and 2003; $850,000
in 2004; $950,000 in 2005; and $1 million in 2006.
observation: There is no provision for indexing the effective exemption after it rises to $1 million in 2006.
observation: One advantage of making gifts
during life is that the post-transfer appreciation in the value of the gifts
will be removed from the donor's estate. An increased unified credit makes it
possible to achieve this advantage to a greater extent without having to lay
out any tax dollars up front.
¶
102. Estate tax exclusion for qualified family-owned business
If an individual dies after '97, and more than 50% of his estate consists of qualified family-owned business interests, the executor may elect to exclude up to $675,000 in value of the interests from the gross estate. The maximum exclusion, however, goes down each year. That's because the exclusion may not exceed the excess of $1.3 million over the exemption equivalent of unified credit. Thus, an estate electing the exclusion is limited to a total exclusion and unified credit exemption of $1.3 million even when the unified credit exemption rises to $1,000,000.
illustration: In 2006, the exclusion is elected for the Smith estate holding a $300,000 business and for the Jones estate holding $1 million dollar business. In each case, the estate is allowed an exclusion of $300,000 and a unified credit exemption of $1,000,000.
A qualified family-owned business is any interest in a trade or business (regardless of the form in which it is held) with a principal place of business in the U.S. if one family owns at least 50% of that trade or business, two families own at least 70%, or three families own 90%, as long as the decedent's family owns at least 30%. An interest in a trade or business doesn't qualify if the business's stock or securities were publicly traded within three years of the decedent's death. The value of a qualifying trade or business is reduced to the extent it holds passive assets or excess cash or marketable securities. Also, an interest generally doesn't qualify if more than 35% of the adjusted ordinary gross income of the business for the year of the decedent's death is personal holding company income.
In addition, the decedent (or a member of the
decedent's family) must have owned and materially participated in the trade or
business for at least five of the eight years before the decedent's death, and
each qualified heir must meet similar participation standards after the
decedent's death. The benefit of the exclusion is subject to recapture if,
within 10 years of the decedent's death and before the qualified heir's death,
a specified recapture event occurs. (§ 502)
¶ 103. Transfer tax indexing
After '98, the $10,000 annual exclusion for gifts, the $750,000 ceiling on special use valuation, the $1,000,000 generation-skipping transfer tax exemption, and the $1,000,000 ceiling on the value of a closely-held business eligible for the special low interest rate (as modified by another provision discussed below) will be indexed annually for inflation. (§ 501(b), (c), (d), and (e))
¶ 104. Installment payments of estate tax on closely held business
Under Code Sec. 6166, an executor generally may elect to pay estate tax attributable to a closely-held business interest in installments over a maximum period of 14-years. If the election is made, the estate pays only interest for the first four years, followed by up to 10 annual installments of principal and interest. A special 4% interest rate applies to the first $ 1 million in value of the business.
For individuals dying after '97, a special 2%
rate applies for the deferred estate tax attributable to the first $1 million
in taxable value of the closely held business (i.e., the first $1 million above
the effective exemption provided by the unified credit). Thus, for example, in
'98, when the unified credit will be increased to provide an effective
exemption of $625,000 (as described above), the amount of estate tax
attributable to the value of the closely held business between $625,000 and
$1,625,000 will be eligible for the 2% interest rate.
observation: This is a great improvement for the decedent's beneficiaries over pre-Act law, which effectively provides the 4% rate against only $400,000.
The interest rate on deferred estate tax attributable to the taxable value of the closely held business in excess of $1,000,000 is reduced to an amount equal to 45% of the rate applicable to underpayments of tax. The interest paid isn't deductible for estate or income tax purposes. (§ 503)
observation: Under pre-Act law, interest on deferred estate tax is deductible as an administration expense but not before the interest accrues. To deduct interest, estates must use a special procedure involving recomputation of installments as interest becomes deductible. Disallowing the deduction and setting the interest rate at 45% of the underpayment rate produces a roughly equivalent result as allowing a deduction at the underpayment rate but without the complexity.
Election for estates of individuals dying before '98. Estates deferring tax under pre-Act law may make a one-time election to use the lower interest rates and forego the interest deductions for installments due after the date of the election. However, electing estate's don't get the benefit of the increase in the amount eligible for the 2% rate--only the amount previously eligible for the 4% rate will be eligible for the 2% rate. (§ 503(d)(2))
observation: Making the election will save some interest and eliminate the need to continue utilizing the cumbersome procedure to recompute estate tax to reflect interest deductions as interest accrues and installments are paid. There is no guidance on how this election is made.
Tax Court jurisdiction. For estates of
decedents dying after the date of enactment, the Tax Court may provide declaratory
judgments regarding initial or continuing eligibility for deferral under Code
Sec. 6166. (§ 505)
¶ 105. Cash leases of specially valued property
For cash rentals occurring after '76, a cash lease of specially-valued real property by a lineal descendant of the decedent to a member of the lineal descendant's family, who continues to operate the farm or closely held business, doesn't cause the qualified use of such property to cease for purposes of imposing the additional estate tax under Code Sec. 2032A(c). (§ 504)
observation: While this provision is effective
retroactively, there is no special provision that would reopen a year closed by
the limitations period.
¶ 106. Reduction in estate tax for land subject to permanent conservation easement
For estates of decedents dying after '97, an executor may exclude from the taxable estate 40% of the value of any land subject to a qualified conservation easement if:
...the land is located within 25 miles of a metropolitan area, or a national park, or a wilderness area, or within 10 miles of an Urban National Forest;
...the land was owned by the decedent or a member of the decedent's family at all times during the three-year period ending on the date of the decedent's death; and
...a qualified conservation contribution (within the meaning of Code Sec. 170(h)) of a qualified real property interest had been granted by the decedent or a member of his family.
The exclusion may be taken only to the extent
that the total exclusion for qualified conservation easements does not exceed
$500,000 when fully phased in for decedents dying after 2001. The limit is
$100,000 for '98; $200,000 for '99; $300,000 for 2000; and $400,000 for 2001.
(§ 508)
¶ 107. Revaluation of gifts for estate tax purposes
In computing the current year's gift tax, the value of gifts made in a preceding period can't be changed if the statute of limitations has expired and a gift tax was assessed or paid for the preceding period. (Code Sec. 2504(c)) However, IRS says that use of the unified credit does not result in the payment or assessment of gift tax for purposes of the revaluation bar. (Rev Rul 84-11, 1984-1 CB 201) Many courts have held that the Code Sec. 2504(c) revaluation bar does not apply for estate tax purposes. For gifts made after the date of enactment, the Act provides that a gift for which the limitations period has passed can't be revalued for purposes of determining the estate tax bracket and available unified credit if the value of the gift was shown on the gift tax return, or was disclosed in the return or an attached statement, in a manner adequate to apprise IRS of the nature of the gift. (§ 506(a))
To revalue a gift that has been adequately disclosed on a gift tax return, IRS must issue a final notice of redetermination of value within the limitations period. This rule is intended to apply even where no gift tax is payable out of pocket because of use of unified credit.
observation: This reverses IRS's position of Rev Rul 84-11 and is achieved in the statutory language because Code Sec. 2504(c) is modified to delete the requirement that gift tax on the prior gift must have been assessed and paid for the revaluation bar to apply. In addition, the estate tax revaluation bar is contained in Code Sec. 2001(f), which has no requirement that gift tax have been assessed and paid for the bar to apply.
observation: The practical effect of the new position is that individuals will not have to permanently retain appraisals and other evidence of valuation of property that's difficult to value.
caution: The change to the gift tax revaluation bar and the new estate tax revaluation bar apply only to gifts made after enactment. IRS can still seek to revalue pre-enactment gifts for estate tax purposes and even for gift tax purposes if unified credit was used and tax was not paid out of pocket.
¶ 108. Statute of limitations suspended for inadequately disclosed gifts
Under pre-Act law, for gifts that are valued under the special valuation rules, the gift tax statute of limitations runs only if the gift is disclosed on a gift tax return in a manner adequate to apprise IRS of the nature of the item. For gifts made in calendar years ending after the date of enactment, this rule has been extended to all gifts so that the statute of limitations will not run on an inadequately disclosed transfer regardless of whether a gift tax return was filed for other transfers in that same year. (§ 506(b))
Declaratory judgments for value of gifts. For gifts made after enactment, the Tax Court is given the power to issue declaratory judgments on the value of gifts shown or disclosed on a return if there is a dispute with IRS and the donor has exhausted all administrative remedies (§ 506(c))
¶ 109. Trust throwback rules
Effective generally for distributions in tax years beginning after the date of enactment, the throwback rules for amounts distributed by a domestic trust are repealed. The throwback rules continue to apply to foreign trusts, domestic trusts previously treated as foreign trusts (except as provided in regs), and domestic trusts created before Mar. 1, '84, that would be treated as multiple trusts under Code Sec. 643(f). (§ 507(a))
observation: The purpose of the throwback rules was to limit the extent to which trusts could be used to reduce tax by accumulating income in trusts and having it taxed to the trusts, rather than by paying it out and having it taxed to beneficiaries. However, now that trust income tax brackets are more highly compressed than those that apply to individuals, there is little opportunity to save tax by accumulating income in trusts and, in that sense, the throwback rules were no longer needed.
¶ 110. Broadening of Generation Skipping Tax predeceased parent exception
Under the "predeceased parent exception," a direct skip transfer to a transferor's grandchild is not subject to the GST tax if the child of the transferor who was the grandchild's parent is deceased at the time of the transfer. This exception is extended to transfers to collateral heirs, provided that the decedent has no living lineal descendants at the time of the transfer, and to certain taxable terminations and taxable distributions, for generation skipping transfers occurring after '97. (§ 511)
¶ 111. Estate and gift tax
simplification
The following are key simplification provisions contained in the Act:
Gift tax returns won't have to be filed for most charitable gifts made after enactment. (§ 1301)
For tax years beginning after enactment, an executor may elect to treat distributions paid within 65 days after the close of the estate's tax year as having been paid on the last day of the tax year. (§ 1306)
For individuals dying after enactment, the rule of certain cases treating transfers from a revocable trust as made directly by a grantor has been codified so that an annual exclusion gift from such a trust will not be brought back into the gross estate. (§ 1310)
For individuals dying after enactment, an
irrevocable election can be made to treat a qualified revocable trust as part
of the decedent's estate for federal income tax purposes. (§ 1305)
observation: The election would make it
possible to gain some income tax advantages that are available to estates but
not to revocable trusts.
2000