FEDERAL ESTATE TAX LAW AND ESTATE TAX PLANNING

     Under our system of federal estate taxation, a tax may be assessed against a decedent's estate based on the value of the property he or she owned. However, not all estates are subject to the federal estate tax. Generally, a portion of a decedent's estate can pass to his or her heirs free from federal estate taxes. The amount that can pass tax-free is referred to as the "applicable exclusion amount." If the value of a decedent's gross estate is less than the applicable exclusion amount, the estate is not subject to any federal estate tax. If the value of a decedent's estate is above or close to the applicable exclusion amount, various tools and tax planning techniques can be utilized to minimize or eliminate the potential estate tax.

     However, the Economic Growth and Tax Relief Reconciliation Act of 2001 (the "Act") became law on June 7, 2001, and, as the name implies, changed numerous provisions of the federal tax code. A significant change among the Act's provisions is a repeal of the federal estate tax. Consequently, some may believe that estate tax planning is no longer necessary. But, quite to the contrary, because of the tentative nature of the repeal, taxpayers need to be even more diligent in reviewing and evaluating their estates to determine if they could benefit from any tax planning opportunities that could quickly become unavailable.

Immediate Estate Tax Benefits of the Act

     Some provisions of the Act have an immediate effect on federal estate taxes. Under the pre-Act federal estate tax law, the applicable exclusion amount was scheduled to increase to a maximum of $1,000,000 in 2006. Now under the Act, the applicable exclusion amount is set at the following amounts (based on the year of the decedent's death):

$1,000,000 for 2002 and 2003;

$2,000,000 for 2004;

$3,000,000 for 2005-2008;

$3,500,000 for 2009; and

$4,000,000 for 2010.

     In addition to increasing the applicable exclusion amount, the Act also eliminates the top federal estate tax brackets. The results of both these changes are that over the next nine years, a greater amount can pass free of federal estate taxes under the increasing applicable exclusion amount and the federal estate tax on the taxable portion of an estate will also steadily decline. This may create current tax planning opportunities for some estates that would become unavailable if the Act expires or is repealed.

Federal Estate Tax Repeal

     Under the Act, the estate tax repeal is scheduled to go into effect on January 1, 2011. However, the Act also includes a "sunset provision" which means that by the terms of the Act itself, all of its provisions expire on December 30, 2010. Since the estate tax repeal is not scheduled to take effect until January 1, 2011, the estate tax repeal will not occur. Instead, on January 1, 2011, all the pre-Act federal estate tax laws spring back into place. For the estate tax repeal to occur, Congress must pass a subsequent law that extends the applicability of the estate tax repeal provisions beyond December 30, 2010. Furthermore, at anytime prior to the Act's self-imposed expiration date, any provision of the Act could be amended or repealed. Under such contingencies, an actual and final repeal of the federal estate tax remains highly uncertain.

The Washington State Estate Tax

     In addition to the federal estate tax, Washington State also has an estate tax. Called a "pick-up tax," the Washington State estate tax is equal to the credit for state estate tax paid as allowed under the federal estate tax laws. However, the Act provides for reductions in this credit. Beginning in 2002, the credit for state estate tax paid is reduced by 25% each year until the credit is repealed in 2005. The credit is then replaced by a deduction for state estate tax paid. As the Washington State estate tax is based on the federal estate tax credit, when the federal estate tax credit is eliminated there will be no Washington State estate tax. At this time, there is no plan to change Washington State's estate tax system to provide for the taxation of estates starting in 2005. Again, though, if the Act expires in 2011 and the old pre-Act federal tax laws spring back into effect, so too will the federal credit meaning Washington State will once again receive a portion of the tax on taxable estates. Nevertheless, as the Washington State budget becomes leaner, legislatures may be unable to afford the loss of this source of revenue for any period of time (estimated at approximately $87 million in 2000), and changes to Washington State's estate tax laws may be forthcoming.

     Increases in the applicable exclusion amount, reduction in tax rates and the eventual repeal of the federal estate tax are all good news for taxpayers. However, because all of these changes are a part of the Act, they are temporary unless subsequent legislation affirms them. Therefore, taxpayers need to be even more diligent in reviewing and evaluating their estates to determine if they could benefit from any tax planning opportunities that would become unavailable if the Act expires or is repealed.

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