By Paul N. Gada, Business Owner's Toolkit Staff Writer

The Economic Growth and Tax Relief Reconciliation Act of 2001 (the Tax Relief Act), which was passed by Congress on May 26, 2001 and is expected to be signed by President George W. Bush on June 7, contains many changes benefiting taxpayers over the next ten years. For example, newly enacted pension provisions reward small business owners for setting up a retirement plan. However, the Tax Relief Act also includes significant changes to our estate tax system that make it a ten-year-long tax planning nightmare.

Nobody likes to pay taxes. In particular, no taxpayer of sound mind and body likes to pay estate taxes, also known as death taxes.

Whether you view it as one of the last vestiges of communism or a noble attempt to redistribute wealth to those less fortunate, our estate tax system essentially penalizes those who are too successful at accumulating wealth. For example, an estate caught with too much money in 2001 must pay a top federal estate tax rate of 55 percent. A state tax also may be imposed.

For a successful small business owner who has worked hard to become prosperous and has already paid taxes on the income earned, it just doesn't seem right to lose such a big chunk of money to the government. If you run a family business, you don't consider Uncle Sam as part of your family and want the business to carry on after you are gone. Fortunately, estate planning experts know the tax rules involved and can help you lessen or eliminate your estate tax burden when passing along wealth to your heirs.

The Tax Relief Act makes it more necessary than ever to seek out professional help with the estate planning process. At first glance, the new estate tax laws appear good because they raise the estate tax exemption amounts, lower the top estate tax rate and eliminate the estate tax entirely in 2010. The breakdown for each year is as follows:

Starting in 2004, the legislation also repeals the controversial qualified family-owned business (QFOB) deduction that was established in 1997. The QFOB deduction was criticized as being overly complicated and not very helpful to the estates of small family business owners. The elimination of this deduction is more than made up by the increased estate tax exclusion amounts. Also important to small business owners are provisions of the new legislation that expand the availability of installment tax payment provisions to estates that include holding companies for closely held businesses.

The benefits of the Tax Relief Act are scaled back, however, by a number of corresponding estate tax rules, rates and exemptions. When taken together, each year of the next decade will have its own complexity and uncertainty concerning how the new estate tax rules may potentially affect you and your business. The following are major areas of concern:

Estate Tax Is Not Dead

The new law repeals the estate tax for only one year--2010. Due to Congressional budgetary restrictions, the estate tax will automatically arise from its temporary grave in 2011 and be restored to its present form (i.e. the law as it exists in 2001). Although Congress will be forced to address this issue at some point between now and then, this doesn't ease the huge uncertainty that this creates for estate planning purposes going forward.

Changes to State Tax Obligations

The Tax Relief Act phases out the federal estate tax credit for state death taxes paid through 2004. The credit is eliminated in 2005 and becomes a deduction for the estate from then on. A tax credit is usually better than a deduction, and this change effectively reduces the Act's overall estate tax relief for taxpayers.

Moreover, this change and the reduction/elimination of federal estate taxes will have a negative impact on the revenues of many states that may total billions of dollars. For example, New York, New Jersey, New Hampshire, Florida and Pennsylvania derive revenues from state death taxes that exceed 2 percent of their total tax revenues. With such holes in their budgets, the states will have to make up the shortage somewhere. So, look for some politically unpopular decisions involving higher taxes possibly coming to your state in the next decade.

Your Assets Ten Years from Now

Once the estate taxes are fully repealed in 2010, a modified carryover basis rule will go into effect. Currently, those receiving assets from an estate receive them at a stepped-up basis or current market value. This means that those receiving the assets will essentially avoid paying capital gains tax on the difference between the original price of an asset and the asset's value at the time of transfer.

With a carryover basis, the person receiving an asset is treated as if they were the original purchaser. If they later sell the asset, capital gains tax will be applied on the difference between the original price and the sales price. The modified carryover basis that will apply in 2010 has some exceptions ($1.3 million of basis is added to certain assets and $3 million of basis is added to transfers to a spouse), but the principle is still the same. So, you don't want to get caught with a lot of appreciated assets in your estate if you plan on dying in 2010.

In the 1970s, Congress tried to impose a carryover basis during estate tax reform, but the law was repealed 6 months later because it created a record-keeping nightmare. For example, assets that have been in the family for generations will require generations of accurate records of basis. Without such records, the IRS will set its own value, which tends to be low, and result in higher tax liability.

On the bright side, Congress did not tamper with current planning techniques that involve lifetime transfers to reduce the size of your estate. Examples of these techniques include the grantor retained annuity trust (GRAT) and family limited partnerships. Consult with your estate tax planner to find out which technique works best for you.

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