Estate, Gift and Generation-skipping Transfer Tax Highlights

California CPA, August, 2001 by Stuart R. Josephs

July's California CPA, Page 10, highlighted some of the provisions in the 2001 Economic Growth and Tax Relief Reconciliation Act. Following is a summary of provisions affecting estate, gift and generation-skipping transfer (GST) taxes.

The estate, gift and GST taxes are reduced from 2002-09. The estate and GST taxes are repealed for 2010 only.

Caution: Because of budgetary restrictions, the current estate tax rules, rates and exemptions will be reinstated in 2011 unless further legislation is enacted.

For 2002, the 5-percent surtax, which phases out the benefit of the graduated rates, and the tax rates exceeding 50 percent are repealed. Also, for 2002, the unified credit effective exemption will be increased from $700,000 to $1 million for both estate and gift tax purposes. These and other changes for subsequent years are summarized in the chart on Page 26.

The estate tax deduction for family-owned business interests will be repealed for estates of decedents dying after 2003.

For gift tax purposes, except as provided in regulations, a transfer to a trust after 2009 will be treated as a taxable gift unless the trust is treated as wholly owned by the donor or the donor's spouse under the grantor trust rules.

State Death Taxes

The state death tax credit allowable under the old law will be reduced by the following percentages:

Year  Percentage Reduction


2002       25 percent
2003       50 percent
2004       75 percent

For 2005 and subsequent years, this credit is repealed--and, instead, a deduction will be allowed for state death taxes.

Property Acquired From a Decedent

Property acquired from a decedent dying after 2009 will be treated as transferred by gift. The old-law rules that would have prescribed a fair market value basis for such property are repealed.

Instead, a modified carryover basis regime generally will take effect. Recipients of property transferred at the decedent's death will receive a basis equal to the lesser of:

* The decedent's adjusted basis for the property; or

* The property's FMV on the date of the decedent's death.

Since such property is treated as if acquired by gift, the character of the gain on the property's sale is carried over to the heir. For example, real estate that had been depreciated and subject to depreciation recapture, if sold by the decedent, will be subject to recapture if sold by the heir.

Basis Increase for Certain Property

The executor will be allowed to increase the basis of assets acquired from a decedent dying after 2009 up to a total of $1.3 million plus the decedent's:

* Unused capital loss carryovers;

* Unused net operating loss carryovers; and

* "Built-in" losses.

Built-in losses are losses that would have been allowable under IRC Sec. 165 if the property acquired from the decedent had been sold at FMV immediately before the decedent's death.

The basis of property transferred to a surviving spouse can be increased by an additional $3 million, for a total increase of $4.3 million.

Nonresident aliens will be allowed to increase the basis of property by up to $60,000.

These $1.3 million, $3 million, and $60,000 amounts will be adjusted annually for inflation in the case of decedents dying after 2010.

Eligible Property

The basis of property may be increased above the decedent's adjusted basis for that property only if the property is owned, or treated as owned, by the decedent at death.

In the case of property held with the surviving spouse as joint tenants or tenants by the entireties, one-half of the property will be eligible for the basis increase. For other property held jointly with a non-surviving spouse, the portion of the property attributable to the consideration furnished by the decedent will be eligible for the basis increase.

The decedent also will be treated as having owned the surviving spouse's one-half share of community property, which will be eligible for the basis increase if at least one-half of the property was owned by, and acquired from, the decedent. Thus, similar to the rule in Sec. 1014(b) (6), both the decedent's and the surviving spouse's share of community property could be eligible for the basis increase.

Ineligible Property

Property not eligible for a basis increase includes:

* Property that was acquired by the decedent by gift (other than from his/her spouse) during the three-year period ending on the date of the decedent's death;

* Property that constitutes a right to receive income in respect of a decedent;

* Stock or securities of a foreign personal holding company;

* Stock of a domestic international sales corporation (or former domestic international sales corporation);

* Stock of a foreign investment company; and

* Stock of a passive foreign investment company (except if the decedent had made a qualified electing fund election).

Allocation Rules

Basis increase will be allocable on an asset-by-asset basis (e.g., basis increase can be allocated to a share of stock or a block of stock). However, in no case can the basis of an asset be adjusted above its FMV.

If the amount of basis increase is less than the FMV of assets whose bases are eligible to be increased under these rules, the executor will determine which assets and to what extent each asset receives a basis increase.