What you need to know about the Economic Growth and Tax Relief Reconciliation Act of 2001

On June 7, President Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 into law. While income tax rate cuts have dominated the headlines, the Act also makes other important changes to existing gift and estate tax law. Specifically, the Act reduces the estate tax over a period of about nine years. However, under current law, it is only repealed in the year 2010. It comes back into existence in 2011 at the current tax rates.

The Act gradually increases the exemption equivalent, or the amount a person may transfer at death free of estate tax, and gradually decreases the maximum estate and gift tax rates. For an explanation of the rate changes, please see the chart on page three.

The Act also provides for the gradual phaseout of the Generation Skipping Transfer Tax. The GSTT exemption amount will be increased during the years 2002 through 2010 so that it matches the exemption equivalent.

While the Act slates the elimination of the estate and generation skipping transfer taxes for the year 2010, the Act also makes significant changes to the current rules related to the basis of property acquired from a decedent. The property acquired from a decedent dying before 2010 receives a step up in basis to the market value of the property on the decedent's date of death. In community property states, the benefit of this stepped up basis is doubled, as both halves of the community estate receive the stepped up basis.

For decedents dying during the year 2010, the basis in property will be equal to the lesser of the market value of the property at the decedent's date of death or the decedent's basis in the property. The Act provides two important exceptions to this rule. First, the Act permits a decedent's estate to increase the basis of property by up to a total of $1.3 million for property passing to a person other than the surviving spouse. A surviving spouse will enjoy an additional step up in basis of $3 million. Consequently, under the Act, only very large estates will fail to receive a stepped up basis in all property of the estate.

Curiously, the Act is designed to disappear on December 31, 2010, putting current tax law back in place. This means that the current estate tax and generation skipping transfer tax will be reinstated which will only allow an exemption equivalent of $1,000,000 and will impose the highest estate tax rate of 55%. Consequently, the Act is probably not the last word on tax reform. Many experts believe that the estate and generation skipping transfer taxes will not be eliminated, as future administrations will likely make modifications returning to a tax structure closer to present law. If this seems pessimistic, remember that the United States had an estate tax before it had an income tax!