Harbor law review

A TAXING SITUATION

     Congress has passed the long awaited new federal tax law.  There are changes in both the estate and income tax areas.  There is some good news in the estate tax area, particularly for wealthy persons with large estates.  There is also some bad news in the income tax area.  Specifically, the reduction and/or potential repeal of the estate tax will be accompanied by a significant increase in capital gains income tax.  A small percentage of people – less than 2%-- will benefit by the estate tax provisions at the expense of the rest of us who have to pay increased capital gains tax as a result of the repeal of the step up in basis rule.  There will be tax planning opportunities and pit falls as we go forward.  Some of the key provisions of the new law are as follows: 

§ Estate tax repeal and Gift taxes:  As noted above, the unified credit is to be increased each year through 2009.  In 2010, the federal estate tax is to be repealed entirely.  Because the increased credits and reduced tax rates are being phased in over a ten year period, the legislature is postponing the loss of revenue over a long period of time.  The question is, will future legislation repeal the elimination of the federal estate tax between now and 2010?  Furthermore, the Federal gift tax is not being repealed.  The new law creates a $1 million lifetime gift tax exclusion beginning in 2002. In addition, gift tax rates will be gradually reduced to bring them into line with the highest individual income tax rates.

§ Repeal step-up in basis:  To accommodate the loss of revenue from estate taxes, the legislature is repealing the step-up in basis rule in 2010.  Currently, when you inherit property from a decedent you get a step-up in basis to the

date of death value.  Your basis in the property which you inherit is the fair market value of the property as of the date of the decedent’s death, not the amount that the decedent paid for the property.  If you subsequently sell the property, your capital gains would be based upon the difference between the sale price of the property and the date of death value.  As a result, you get a “step-up in basis” to the date of death value.  However, the new tax law will repeal the step-up in basis rule as of 2010.  Therefore, if you inherit appreciated property from the decedent your basis will be the same as the decedent’s basis, not the fair market value as of the date of the decedent’s death.  This will mean two things.  First of all, everyone who inherits appreciated property will be paying significantly more capital gains tax.  Secondly, you will need to keep accurate records of your basis in any property that you own, including your home, real estate, stocks, bonds and other investments.  Because your children and heirs will have a carry-over basis, not a stepped-up basis, they may have to pay

capital gains tax on years of appreciation, not on the appreciation in value from the date of your death until the date they sell the property.

Income Taxes

There are numerous changes in the federal income tax laws, including the following:

§ Rate cuts:  The new legislation creates a new 10% income tax rate.  The lowest rate is currently 15%.  Also, the new legislation reduces existing income tax rates.  Effective July 1, 2001 income tax rates will be reduced by approximately 1% every other year.

§  IRA contribution limits:  Currently, both traditional and Roth IRA contributions are limited to $2,000.00 per year.  Starting in 2003 contribution limits will be gradually increased to $5,000.00 per year.  Also, there will be higher limits for persons age 50 and older.  

§ Employee retirement plans:  There will also be higher contribution limits for 401(K) and other types of employer sponsored retirement plans.  Contribution limits will increase gradually from $10,500.00 per year to $15, 000.00 per year.  Contribution limits for Simple Plans will also increase from $6,500.00 per year to $10,000.00 per year in 2005.  Also, persons aged 50 and over will be able to make additional contributions.  In addition, there is a new “Roth style” 401(K) plan that allows employees to make non-deductible contributions to their 401(K) plan so that benefits are not taxable when they are received at retirement.    

These are just some of the changes in the estate and the income tax laws enacted by Congress.  As you can tell, most of the tax benefits will be phased in over many years.  Obviously, this gives Congress a chance to alter or repeal some of the changes depending on changing economic circumstances.  More importantly, while there are increased opportunities for planning, the need for planning still exists.  Even though the new law will reduce and, hopefully, ultimately repeal estate taxes, the new law has not repealed the need for retirement and estate planning.  The reasons for good planning still exist.  Those include not only reducing or eliminating the tax consequences of various types of transfers, but also reducing other transactional costs such as the cost of probate.  This is a good time look at any estate or probate issues that you may have.  If you have questions about these issues, please let us know.

Michael McShane

Social Security Launches New “For Women” Page

The Social Security Administration has a new page on their website devoted to women.  “For Women” www.ssa.gov/women, provides links to basic information throughout SSA’s website that can be relevant to women at different stages of their life.