Estate, Gift and Generation-skipping Transfer Tax Highlights.

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 The estate and GST taxes are repealed for 2010 only.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the 5-percent surtax, which phases out the benefit of the graduated rates, and the tax rates exceeding 50 percent are repealed.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The estate tax deduction for family-owned business interests will be repealed for estates of decedents dying after 2003.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For 2005 and subsequent years, this credit is repealed--and, instead, a deduction will be allowed for state death taxes.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 The old-law rules that would have prescribed a fair market value basis for such property are repealed.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.

Reporting Requirements

Lifetime Gifts After 2009

A donor must provide each donee with a written statement showing:

* The donor's name, address, and phone number; and

* Information relating to the property received by the donee that was reported on the gift tax return, such as the property's basis and FMV.

This statement must be furnished no later than 30 days after the gift tax return is filed.

Transfers at Deaths Occurring After 2009

For transfers at death of noncash assets exceeding $1.3 million, and generally for appreciated property received by a decedent within three years of death, the executor of the estate (or the trustee of a revocable trust) must report to the IRS:

* The name and taxpayer identification number of the recipient of the property;

* An accurate description of the property;

* The property's adjusted basis in the decedent's hands and its FMV at the time of death;

* The decedent's holding period for the property;

* Sufficient information to determine whether any gain on the property's sale would be treated as ordinary income;

* The amount of basis increase allocated to the property; and

* Any other information that the IRS may prescribe.

This report must be filed with the decedent's final income tax return or a later date specified in regulations.

The executor (or trustee) also must provide each recipient of such property (except the executor or trustee) with a written statement showing:

* The executor's (or trustee's) name, address, and phone number; and

* The information specified above relating to the decedent's property acquired by the recipient.

This statement must be furnished no later than 30 days after the report is filed with the IRS.

Penalties

Any donor required to provide donees with information relating to gifts reported on the donor's gift tax return is liable for a $50 penalty for each failure to report such information.

Any person required to report to the IRS transfers at death of noncash assets exceeding $1.3 million, and who fails to do so, is liable for a $10,000 penalty. Any person required to report to the IRS the receipt by a decedent of appreciated property acquired by the decedent within three years of death for which a gift tax return was required to have been filed by the donor, and who fails to do so, is liable for a $500 penalty. There also is a $50 penalty for each failure to report such information to a beneficiary.

No penalty is imposed if a failure is due to reasonable cause. If any failure to report to the IRS or a beneficiary is due to intentional disregard of the rules, the penalty is five percent of the FMV of the property for which reporting was required, determined at the date of the gift or the decedent's death.

Income Tax Exclusion for Gain on the Sale of a Principal Residence

The $250,000 exclusion under Sec. 121 will apply to property sold by a decedent's estate, heir or qualified revocable trust (defined in Sec. 645(b)(1)); determined by taking into account the decedent's ownership and use of the property as a principal residence.

This new rule will be effective for estates of decedents dying after 2009.

Relief From Late GST Tax Elections

The new law authorizes and directs the IRS to grant extensions of time to make the election to allocate the GST tax exemption and to grant exceptions to the time requirement, without regard to whether any period of limitations has expired. If such relief is granted, the gift or estate tax value of the transfer to the trust would be used for determining the GST tax exemption allocation.

Under the old law, an election to allocate the GST tax exemption to a specific transfer may be made up to the time for filing the transferor's estate tax return. If an allocation is made on a gift tax return filed timely with respect to a transfer to a trust, the value on the date of such transfer is used for determining the GST tax exemption allocation. However, if the allocation relating to a specific transfer is not made on a timely-filed gift tax return, the value on the date of allocation must be used. There was no statutory provision allowing relief for an inadvertent failure to make an election on a timely-filed gift tax return to allocate the GST tax exemption.

In determining whether to grant relief for late elections, the IRS is directed to consider all relevant circumstances, including evidence of intent contained in the trust or transfer instrument and such other factors as the IRS deems relevant. In making this determination, the time for making the allocation (or election) is treated as if not expressly prescribed by statute.

This relief applies to requests pending on, or filed after, 2000. No inference is intended regarding the availability of late election relief before this effective date.

Substantial Compliance for Allocating the GST Tax Exemption

Under the old law, there was no statutory rule which provided that substantial compliance with the statutory and regulatory requirements for allocating the GST tax exemption would suffice to establish that this exemption was allocated to a particular transfer or trust.

The new law provides that substantial compliance with the statutory and regulatory requirements for allocating the GST tax exemption will suffice to establish that this exemption was allocated to a particular transfer or trust. If a taxpayer demonstrates substantial compliance, then so much of the transferor's unused GST tax exemption will be allocated to the extent it produces the lowest possible inclusion ratio.

In determining whether there has been substantial compliance, all relevant circumstances will be considered, including evidence of intent contained in the trust or transfer instrument and other such factors as the IRS deems appropriate.

This provision applies to transfers subject to estate or gift tax made after 2000. No inference is intended with respect to the availability of a substantial compliance rule before this effective date.

Stuart R. Josephs, CPA, has a San Diego-based Tax Assistance Practice (TAP) that specializes in assisting practitioners in resolving their clients' tax problems. Josephs, chair of the Federal Subcommittee of CalCPA's Committee on Taxation

 Transfer Tax Exemptions and Rates 2002--10

Calender  Estate & GST Tax Deathtime  Gift Tax Lifetime
Year      Transfer Exemption          Transfer Exemption


2002      $1 million                  $1 million
2003      $1 million                  $1 million
2004      $1.5 million                $1 million
2005      $1.5 million                $1 million
2006      $2 million                  $1 million
2007      $2 million                  $1 million
2008      $2 million                  $1 million
2009      $3.5 million                $1 million
2010      N/A (estate & GST           $1 million
          taxes repealed)

Calender  Highest Estate &
Year      Gift Tax Rates


2002      50 percent
2003      49 percent
2004      48 percent
2005      47 percent
2006      46 percent
2007      45 percent
2008      45 percent
2009      45 percent
2010      Top individual income tax
          rate for gift tax only