Estate Tax Issues and the 1997 Federal Tax Law

Warning: This article is not up to date and will not be updated.  The laws with respect to federal estate and gift tax have changed substantially since the publication of this article. Do not rely on the information contained here.  It is maintained for historical purposes only.

ESTATE AND GIFT TAX HIGHLIGHTS FROM THE NEW TAX LAW
By Richard Magnone © 1997

In August, the President of the United States signed H.R. 2014 into law. The bill is a long awaited and highly publicized tax reform bill that provides for sweeping changes to both income and estate taxes. As expected, Congress has increased the estate tax credit. However, Congress also included a few less publicized provisions such as those affecting gift taxes, small businesses, and the administration of the estate tax system.

INCREMENTAL INCREASE IN UNIFIED CREDIT

Congress has finally addressed the problem of an estate and gift tax credit that has not changed in over a decade. The law will increase the unified credit (which can be used to offset either estate or gift tax, but which reduces the estate credit by the value of the gift credit used by the time of death) from its current level of $600,000 in increments of $25,000 per year until the year 2006. Therefore, the credit for persons dying in 1998 will be $625,000. For 1997, the credit remains at $600,000.

What does the change in the credit mean to you? If you have a will or similar estate planning instrument that takes advantage of a “true pecuniary gift,” that is, one which states a specified dollar value gift intended to offset the unified credit, such as a will leaving $600,000 to a trust, then that will or estate planning instrument should be amended to reflect the new exemption amounts. To avoid the unnecessary expense of revising your will on a yearly basis to account for the incremental increase in the estate tax credit, your will can contain a formula which would be flexible enough to reflect the correct unified credit amount regardless of the year in which the clause is invoked.

INDEXING OF ANNUAL GIFT EXCLUSION AND OTHER PROVISIONS

Congress has also made provisions for the inflation indexing of the annual gift tax exclusion, the generation skipping transfer tax exemption and the special use valuation. As a result, the current $10,000 annual gift exclusion will increase to remain on par with inflation. Currently, a taxpayer may gift $10,000 per year per individual without paying any gift tax. Thus, after 1998, a single person may gift an amount equal to the true value of $10,000 in 1998.

EXCLUSION FOR QUALIFIED FAMILY-OWNED BUSINESSES

The tax bill also provides, under certain circumstances, for the transfer of an amount up to an additional $675,000 worth of family owned business estate tax free. The measure works in conjunction with the incremental increase in the estate tax exemption. The code allows for a maximum of $1,300,000 worth of qualified family-owned business interests to be transferred estate tax free. As such, as the estate tax credit increases, the additional exclusion for qualified family-owned businesses will decrease.

Additionally, a business must follow the rigorous requirements of the tax code or the interest will revert back and estate tax will be due. To qualify, the decedent must be a U.S. citizen whose business accounts for half or more of the estate. The decedent or one of his or her family members must have owed and worked in the business for at least five of the prior eight years. In addition, the family must also own 30% of the business. Finally, the decedent’s heirs must be employed in the business for a minimum of ten years after the decedent’s death, otherwise, the estate tax savings may be recovered by the Internal Revenue Service.

LOW INTEREST INSTALLMENT TAX PAYMENTS ON CLOSE-HELD BUSINESS

Congress has also provided for low interest installment payments for estate taxes on closely held businesses. This provision is especially beneficial in cases of small businesses that provide income to family members but which have small amounts of liquid assets. Some heirs will now have the ability to hold those assets and make installment payments of estate taxes at a low interest rate. The tax due on the first $1,000,000 of taxable value of a closely held business will be subject to 2% interest. Any other taxable amounts will be subject to a rate that is 45% of the same rate that applies to tax underpayments.

OTHER PROVISIONS

The law, comprised of hundreds of pages, goes on to make many other changes to the estate and gift tax system. Some other changes: Estate taxes for some land subject to “permanent conservation easements” will be reduced; gifts may not be revalued for estate tax purposes after the three year statute of limitations expires; and throwback rules applicable to domestic trusts have been repealed. The act is now in its infancy and its effects will not be known for some time. Keep watching here for new developments.