To borrow from Mark Twain's famous comment, made on the occasion of reading his own obituary: "Reports of the death of the federal estate tax are greatly exaggerated."

Exclusion Amount: The largest amount that a person can pass free of federal estate taxes, other than amounts that qualify for the marital or charitable deductions.

During the period beginning January 1, 2002, and continuing through December 31, 2009, the federal estate tax will remain in existence. During that time, the exclusion amount will rise in stages from its current level of $675,000 to $1.0 million (2002 and 2003), then $1.5 million (2004 and 2005), then $2.0 million (2006, 2007, and 2008), and finally $3.5 million (2009).

During the same period, the maximum estate tax rate will decline from the current level of 55%, as follows: In 2002, to 50%; in 2003, to 49%; in 2004, to 48%; in 2005, to 47%; in 2006, to 46%; and in 2007, to 45%.

Step-up in income tax basis:
This adjustment allows persons who inherit assets to calculate their gain on resale by reference to the value of the assets at the time of the former owner's death.

On January 1, 2010, if Congress has not acted to alter the law prior to that time, the federal estate tax will be repealed. In its place, the unlimited step-up in income tax basis currently available to all decedents will be limited to $1.3 million worth of appreciation (in the case of assets passing to individuals other than a spouse), and $3.0 million worth of appreciation (in the case of assets passing to a spouse). This means that beneficiaries might have to report capital gains when they sell some inherited assets by reference to the decedent's original cost. Careful record-keeping regarding tax basis will be required. Without it, the "free" portion of the basis adjustment will be lost.

To top things off, the new Tax Act contains a "sunset provision." Under this provision, the federal estate tax will return on January 1, 2011 to where it would have been if the new Tax Act had never been enacted (a $1 million exclusion amount, with a 55% maximum rate).

State Death Tax Credit:
A dollar-for-dollar (up to a maximum) federal estate tax credit for estate taxes levied by a state.

The state death tax credit will be phased out over a three year period, starting in 2002. After 2004, an estate tax deduction will be allowed for state estate taxes paid. The 40 or so states (including Florida) that have based their estate taxes on the "maximum amount of the credit" will need to revamp their estate tax systems to avoid a significant revenue loss. For estates below $4 million, Ohio does not base its estate tax on the credit; accordingly, changes to the Ohio estate tax law may not become necessary as quickly as in the case of other states.

Is all of this, particularly the sunset provision, likely to occur?

While it is impossible to predict the future (especially when Congress is involved), there is a growing consensus among tax professionals that the final changes under the Tax Act are unlikely to occur. Taxpayers can be expected to object to a program that gradually reduces rates, provides a 12 month repeal, and then reinstates the old rates and reduced exclusion.

A Federal government with unlimited funds at its disposal might be expected to extend the repeal beyond its December 31, 2010, expiration date. Given the prospect that budget surpluses will shrink in coming years, Congress seems more likely to restrict its generosity than to expand it.

This may well result in a reconsideration of the idea of "total repeal." In its place, many commentators expect Congress to "freeze" the increase in the exclusion and rate reductions at some point between now and the end of 2009 (most commonly mentioned: a $2 million exclusion and 45% top rate).

If the picture regarding federal estate tax repeal is uncertain, how do I plan for the future?

We are recommending that our clients take a "five year view." This is not a new approach. We have always advised our clients to examine their estate plans periodically after signing, with an eye toward determining whether those plans continue to meet their goals.

A change in the law is only only one of the events that compel review of estate planning documents. Other events of this type include significant changes in net worth, family situation, or one's choices for the individuals or professional fiduciaries selected to carry out one's estate plan.

The changes scheduled to take place during the next five years will not dramatically impact the way that planning documents are presently structured. The revocable trusts we prepare typically utilize a formula that automatically adjusts the amount passing to the Family Trust as changes occur in the amount of the exclusion amount. Changes in the maximum tax rate will not impact the operation of the trust.

Family Trust.:
A trust designed to be funded with property equal in value to the exclusion amount when the first spouse dies. Assets placed in a Family Trust will avoid estate tax at the death of the first spouse to die, and will also be excluded from the surviving spouse's estate at the second death.

How will these changes affect my estate plan?

You and your planning counsel should take time to consider the impact that the increased exclusion amount will have on your estate plan, given the size of your estate and your goals for your beneficiaries.

For example, if you have provided for a Family Trust or share that will operate solely for the benefit of your children (with no benefit for your surviving spouse), the increase in the exclusion from $675,000 to $2.0 million may cause you to rethink whether the amount being diverted for the children is excessive. You may wish to add your spouse as a potential beneficiary of the Family Trust, as a means of keeping the increased amount available for the spouse.

Eventually (but not necessarily immediately), some folks may be able to utilize a simpler estate plan. To the extent that the combined worth of both spouses is less than the amount sheltered by one exclusion amount, there is no tax disadvantage to having all assets pass from one spouse to the other at the death of the first spouse to die.

If the Federal Estate Tax will no longer affect me, do I still need to do estate planning?

Absolutely. Effective asset management requires that every individual have documents in place that will address the questions of how that individual's assets will be managed, and how they will pass, in the event of death or incapacity. Wills, revocable trusts, and durable general powers of attorney continue to provide the essential building blocks for addressing those questions in an effective and efficient manner.

Moreover, individuals have for centuries used trusts as a flexible and highly effective vehicle for managing assets for the benefit of third parties who lack the skills, maturity, or health necessary to manage assets for themselves. This will continue, regardless of the existence of the federal estate tax.

Finally, it remains important for all individuals to utilize health care advance directives (such as health care powers of attorney and living wills) to ensure that health care decision making will proceed in a manner consistent with their wishes when they are no longer able to do so.

Annual Exclusion:
This exclusion allows individuals to make qualifying "present interest" gifts of up to $10,000 per donee, per year, without gift tax consequences.

The new law makes no change to the Annual Exclusion.

Has the gift tax been repealed, too?

No. The gift tax will remain, and it will be assessed on all lifetime transfers, other than those qualifying for the annual exclusion, aggregating more than $1 million. As the estate tax rate drops, the rate applicable to the gift tax will be reduced. Ultimately, the gift tax rate is scheduled to "bottom out" at 35%.

Do I still need to be concerned about maintaining liquidity in my estate?

There are many reasons why liquidity is important, even if one doesn't need to keep funds on hand to pay federal estate taxes. Funds may be needed to fund a buy-out under a "buy sell" agreement, and cash may be needed to support loved ones if an income is cut off as a result of the death of an income-earner. While the repeal (or reduction) of the federal estate tax may eliminate one of the needs for liquidity, others may still be around.

Given the uncertainty regarding ultimate repeal of the federal estate tax, it is important to avoid acting hastily in connection with termination of liquidity-building arrangements, such as life insurance. This is particularly true if the insurance is held in an arrangement that is already sheltered from estate and gift taxes (such as an irrevocable life insurance trust). Termination decisions should be made only after consultation with your financial advisors, and only then with a full understanding of your anticipated financial needs.

If I am presently making annual exclusion gifts, do I need to continue doing so to minimize estate taxes?

The right answer for you will depend on a variety of factors, including your net worth, the age and health circumstances of you and your spouse, and your estate planning goals. Clients who make gifts for planning purposes should consult with estate planning counsel to determine the impact of the new Tax Act on their particular gifting program.

Is the government going to replace the loss of the estate tax with another tax?

In the event that repeal of the federal estate tax goes forward as planned, the government hopes to recoup some of the lost revenues by increasing the amount of capital gains taxes it collects from those who inherit assets. This will result from the limitation in the amount of step-up in income tax basis that will be allowed after the federal estate tax repeal takes effect.

How does the Tax Act change marginal income tax rates?

The Tax Act creates a new 10% regular income tax bracket for a portion of taxable income, currently taxed at 15%, effective for tax years beginning after December 31, 2000. This new rate applies to the first $6,000 of taxable income for single individuals, $10,000 for heads of households, and $12,000 for married couples filing joint returns. These amounts are increased to $7,000 and $14,000, respectively, for tax years 2008 and thereafter.

Individual income rates are likewise reduced, effective July 1, 2001. The present regular income tax rates of 28%, 31%, 36% and 39.6% are phased down over six years to 25%, 28%, 33% and 35%, effective after June 30, 2001. The table below shows how these tax reductions are phased in.

Regular Income Tax Rate Reduction

Because the new 10% tax rate will not be effective until tax year 2002, a $300 tax credit will be mailed to single individuals, $500 to heads of households and $600 to married couples who file a joint return. These credits will be issued in the form of a check from the Treasury.

What effect does the Tax Act have on itemized deductions and personal exemptions?

Beginning in 2006, the overall limitation on itemized deductions and restrictions on personal exemptions will be phased out. These restrictions will be phased out by one-third in tax years 2006 and 2007 and by two-thirds in tax years 2008 and 2009. The overall limitations will be eliminated for tax years beginning after December 31, 2009.

What effect does the Tax Act have on the Alternative Minimum Tax ("AMT")?

The Act will increase the individual AMT exemption amount by $2,000 for single taxpayers and $4,000 for married taxpayers filing joint returns between 2001 and 2004.

What tax benefits does the new Tax Act contain relating to children?

The Act increases the child tax credit to $1,000 per child over a 10-year period; increases the maximum adoption credit for children to $10,000; and expands the dependent care tax credit by increasing the maximum amount of eligible employment-related expenses.

What are the marriage penalty relief provisions in the Act?

The Act increases the basic standard deduction for a married couple filing a joint return to twice the basic standard deduction for an unmarried person filing a single return, over a five year period, beginning in 2005. The Act also increases the size of the 15% regular income tax bracket for a married couple to twice the size of the same bracket for an individual, over a four year period, beginning in 2005.

What are some of the education incentives provided by the new Act?

Effective January 1, 2002, the Act increases the annual limit on contributions to education IRAs from $500 to $2,000 and expands the definition of qualified education expenses that may be paid tax-free from an education IRA to include elementary and secondary school expenses. The Act also increases the phase-out range for contributions to education IRAs for married taxpayers filing a joint return to twice the range for single taxpayers and expands the tax-favored prepaid tuition programs to include certain private educational institutions in addition to certain state sponsored schools.

What positive changes does The Act contain with respect to qualified retirement plans?

The most important changes to qualified retirement plans are:

1. The deduction limit for contributions to profit-sharing plans is increased from 15% to 25%, effective in 2002.

2. The maximum annual addition under a defined contribution plan is increased from $35,000 to $40,000, effective in 2002.

3. The maximum annual benefit under a defined benefit plan is increased from $140,000 to $160,000, effective in 2001.

4. The limit on compensation that can be taken into consideration for qualified plan purposes is increased from $170,000 to $200,000, effective in 2002.

5. The limit of elective deferrals to 401(k) plans is increased from $10,500 to $11,000, effective in 2002, with annual increases thereafter to $15,000 by 2006.

6. Special "catch-up" contributions to 401(k) plans for those age 50 or over, in addition to the normal limit, are permitted in the amount of $1,000 per year, effective in 2002, with annual increases thereafter to $5,000 by 2006.

Are there any negative changes?

Negative changes from the standpoint of employers and plan administrators, include:

1. Faster vesting is required for employer matching contributions, effective in 2002. "Cliff" (all or nothing) vesting of such contributions will have to occur after 3 years, rather than the currently permissible 5 years. Graduated vesting will have to utilize a 2-6 year vesting schedule, rather than the currently permissible 3-7 year schedule.

2. In cashing out small accounts of between $1,000 and $5,000, unless the participant elects otherwise, plan sponsors will have to rollover the funds to an IRA established for the benefit of the participant, rather than merely sending him a check. This provision is not effective until after regulations are issued on the subject, which may not occur for several years, so it will not be effective as soon as most of the other changes.

Is it true that the reductions in tax enacted by the Act will expire on December 31, 2010?

The Act includes a sunset provision which provides that after December 31, 2010, absent other legislation, all tax rates will return to their level prior to passage of the act.

The Act increases the child tax credit to $1,000 per child over a 10-year period; increases the maximum adoption credit for children to $10,000; and expands the dependent care tax credit by increasing the maximum amount of eligible employment-related expenses.