Recent Estate Planning Developments  Summer of 2001 
New Alaska Legislation   June 2001
THE NEW FEDERAL TAX ACT  Important Changes
What Planning Should You Do? 
THE 2001 TAX ACT Changes Which Affect Your Estate Planning
David G. Shaftel 2001.
All rights reserved.
A Summary Provided by the: Law Offices of David G. Shaftel, PC

We have been waiting some time for a new federal tax act which improves the federal gift, estate, and generation-skipping transfer tax laws. On June 7, 2001, the President signed the Economic Growth and Tax Relief Reconciliation Act of 2001. This new law enacts significant changes to the above-listed transfer taxes. The political situation in Congress, plus competing needs for other types of tax cuts, have resulted in many of the transfer tax promised benefits being "phased-in." Ultimate repeal of the federal estate and GST taxes is promised in 2010. However, again because of the political situation in Congress, this repeal "sunsets" in 2011 (see page 3). 


Some of the transfer tax benefits take effect almost immediately. Those we can count on (subject to sunsetting).
 Others will take effect when the phase-in date arrives. At that time, we also probably can count on them.  
 Future"repeal"remains uncertain. Perhaps it would be wise for us to keep in mind that old cliche about not counting your chickens.... 
Here are highlights of the federal gift, estate, and GST tax changes: 
Increase in Gift Tax Applicable Credit Exclusion Amount. At present, each person may make gifts of up to $675,000 during their lifetime without paying any gift tax. In 2002, this amount will be increased to $1,000,000. 
Estate Tax: Credit Exclusion Amount Up and Tax Rates Down. From 2002 through 2009, the applicable credit exclusion amount for estate tax purposes, the GST exemption amount, and the tax rates for both gift and estate taxes, are as follows: 
Calendar Year
Estate Tax Exclusion, GST Tax Exemption
Highest Estate & Gift Tax Rate
$1 million
$1 million
$1.5 million
$1.5 million
$2 million
$2 million
$2 million
$3.5 million
N/A (taxes repealed)
Top individual rate under the bill (gift tax only)
New Act "Sunsets"

Repeal of Estate Tax. In 2010, the estate tax and generation-skipping transfer tax are repealed, but may be reinstated in 2011 (see below). The gift tax will not be repealed. Beginning in 2010, the top gift tax rate will be the top individual income tax rate as provided under the new law.  

New Capital Gains Tax. After repeal of the estate and generation-skipping transfer taxes in 2010, the present-law rules providing for a fair market value (i.e., stepped-up) basis for property acquired from a decedent are repealed. A modified carryover basis regime generally takes effect, which provides that recipients of property transferred at the decedent*s death will receive a basis equal to the lesser of the adjusted basis of the decedent or the fair market value of the property on the date of the decedent*s death. Partial exceptions are made for transfers to a spouse (basis adjustments up to $3,000,000) and to others (basis adjustment up to $1,300,000). 

This new "carryover basis" capital gains tax is similar to the same type of tax which has been enacted twice before (in the 1920s and in 1976). After short periods of time, both prior "carryover basis" taxes were repealed because the administrative record keeping burdens they placed upon taxpayers were found to be unworkable. 

New GST Exemption Rules. A new rule provides for automatic "deemed allocation" of GST exemption to most types of trusts which would be exposed to the GST tax. If planning dictates that allocation be done differently, the taxpayer may opt-out of these deemed allocation rules.

Another new rule allows a partially exempt trust to be severed into a completely GST exempt trust and a completely GST non-exempt trust in the future. Under existing law, such a division was prohibited. 

Finally, special "relief provisions"are enacted to allow the Treasury Secretary to grant extensions of time and exceptions. If such relief is granted, the gift tax or estate tax value of the transfer to the trust would be used rather than the value of the trust*s assets in the future. All of the above GST provisions apply immediately. 

Repeal of Qualified Family Owned Business Interest Deduction. Under existing law, a special benefit existed for small farms and small businesses. In 2001, if certain requirements were met, then for estate tax purposes an additional deduction was available which could not exceed $625,000. In certain situations and with proper planning, each spouse could take advantage of this deduction. While this QFOBI deduction has been criticized for its complexity, it did provide a significant tax benefit.  

The new Tax Act repeals this QFOBI deduction as of December 31, 2003. Interestingly, that is the same date after which the estate tax exclusion is increased to $1,500,000. Some observers comment that this represents "what one hand giveth, the other hand taketh away." 

Conservation Easement Exclusions Improved. The 2001 Tax Act expands the land which can qualify as a conservation easement as any land located in the United States. This is a significant improvement over the prior definition which limited such easements to land located within a certain distance from metropolitan areas, national parks, wilderness areas, or urban national forests. This can be a very attractive estate planning benefit.

The value of a conservation easement may be excluded from the gross estate subject to certain percentage and dollar limitations. Generally, the percentage restriction is 40% of the value of the land, which is further reduced by two percentage points for each percentage point by which the value of the easement is less than 30% of the value of the land. The maximum dollar amount of the exclusion is $400,000 in 2001 and $500,000 in 2002 or thereafter. These changes take effect immediately. 


Qualified State Tuition Programs Are Sweetened. In our last newsletter, we discussed Alaska's new Qualified State Tuition Program authorized by I.R.C. *529. This is a great way in which to set aside funds for the education of children or grandchildren. In summary, you may contribute, gift tax free, $50,000 for a family member*s tuition and education expenses. You may continue to make contributions for a beneficiary every five years. You can invest up to a maximum of $250,000 for each beneficiary. By doing so, you remove the contributed funds from your gross estate. Unlike funds contributed to a child*s or a grandchild*s trust, funds contributed to the plan grow free of income tax. Alaska has added asset protection to the above-described benefits. An account is exempt from a claim by the creditors of the donor or of a beneficiary. You retain the right to change the beneficiary among family members, without penalty. You also retain the right to withdraw the funds placed in the account, but the earnings portion of the withdrawn funds will be taxed at your tax rates and will be subject to a penalty of 10% of the earnings.  

The new 2001 Tax Act has "sweetened" these *529 tuition programs. The law used to be that when amounts were distributed to a student beneficiary, they were taxed at the student*s tax rates. Under the new Tax Act, distributions to the beneficiary which are used to pay for qualified higher education expenses are no longer taxable to anyone. This is a tremendous improvement for I.R.C. *529 tuition programs. The funds that you contribute for the education of your children or grandchildren will grow income tax free, and when distributed for education expenses will be income tax free! This new tax benefit is effective beginning in 2002.

Alaska has chosen the brokerage firm of T. Rowe Price to manage funds contributed to its I.R.C. *529 tuition program. You may obtain more information about this tuition program by going to

IRA Rollovers to Charities Go Sour. For several years charities have been lobbying for a new tax provision which would allow individuals to withdraw amounts from their IRAs, income tax free, if the amounts were directly contributed to a charity. This would be an important improvement compared to the present situation where often the income resulting from the withdrawal is not completely offset by the income tax charitable deduction which the donor receives. The reason for the present mismatching is that itemized deductions on your income tax return are subject to certain limitations as your income grows higher. The Senate version of the new tax bill included the above IRA rollover provision. However, the final 2001 tax bill dropped this provision to satisfy the overall tax cut ceiling.

There is still hope. H.R. 774 is pending in Congress and is designed to accomplish this IRA charitable rollover result. Perhaps this change will be enacted in the near future. It would eliminate the income tax sting for donors who desire to contribute part or all of their IRAs to charities during the donors* lifetimes. 

Pension Changes. The new Tax Act includes more than 50 provisions which are designed to increase retirement savings and pension coverage. A few highlights are as follows: 

1.  Increased IRA Contributions. Under the new Act, the contribution limit for IRAs would be increased to $3,000 for 2002-2004, $4,000 for 2005-2007, and $1,000 annually in 2006 and thereafter. Individuals 50 and older would be allowed to make catchup contributions to an IRA of $500 annually through 2005, and $1,000 annually in 2006 and thereafter. 

2. Increased 401(k) Limits. Annual elective deferral limits for 401(k) and 457 plans, and 403(b) annuities would be raised from $10,500 to $11,000 in 2002 and then increase in $1,000 increments to reach $15,000 for 2006 and thereafter. Additional catchup contributions to such plans (available for individuals 50 and older) would begin at $1,000 for 2002 and increase by $1,000 annually to reach $5,000 in 2006. 

3. Additional Increased Limits. Annual contribution limits with respect to each plan participant in a defined contribution plan were increased from $35,000 or 25% if compensation to $40,000 or 100% of compensation. The annual benefit limit under a defined benefit plan was increased from $140,000 to $160,000. 

Other Tax Act Changes. Our discussion above has focused upon only the transfer tax changes and several income tax and pension tax changes which are of primary interest for your estate planning. The Tax Act contains numerous other changes relating to income tax rate cuts, marriage penalty relief, individual tax credit changes, educational benefits involving IRAs, deductions and interest, and miscellaneous other provisions. These subjects are beyond the scope of this newsletter. However, our web site contains links so that you may find a full discussion of the new Tax Act on the Internet. 

The Entire 2001 Tax Act "Sunsets" on December 31, 2010. When this new Act was passed by the Senate, there were not enough votes for it to avoid the application of the "Byrd Rule" contained in the 1974 Budget Act. What that means is that to pass, the tax cut package had to "sunset" after ten years. The bottom line is that the above-described changes and the estate tax repeal in 2010 will only be effective until December 31, 2010. At that time, all of these changes will "sunset," that is, will terminate. The Federal Gift, Estate and GST tax laws will then go back to what they were in 2001. This has been named the "Cinderella" provision. 

Probable Congressional Reconsideration of All of These Changes. The above-described "sunsetting" of the new Act on December 31, 2010 will very probably cause Congress to reconsider the Tax Act. When this occurs, other changes or adjustments may be made to the tax law. This will depend upon the political situation in Congress and the Executive Branch, and other factors such as our national economic situation, and the needs of programs such as social security and health care.


The new Tax Act, which is the result of unusual political and national financial circumstances, has produced mixed blessings. On the positive side, the Act presents the promise of significant reduction and even repeal of the estate and GST taxes. On the negative side, the Act presents increased planning complexity. We now, in effect, have four tax regimes: the existing 2001 law; the phase-in law from 2002 until 2009; repeal in 2010; and sunset in 2011. 

The complexity of four tax regimes is further complicated by the uncertainty of eight Congresses and new presidential administrations prior to 2010. In addition to the uncertainty of the law, we have the uncertainty of our longevity. Perhaps this is best illustrated by the "gallows" humor now circulating that under the new Tax Act we should plan to die in 2010. At present, that is the only year under the new Act when the estate tax will be repealed.  

So, what should you do? 

Initially, it is important to place this subject in perspective. The new Tax Act only focuses upon one aspect of estate planning: reduction of transfer taxes. Whatever the size of your family's estate, tax reduction is only one planning goal and may not be the most important. Most clients are primarily concerned with their dispositive plan. Where will the assets go after the first spouse's death, and then when both spouses die? How will these assets be protected, managed, and ultimately distributed for the benefit of the children, grandchildren, and other beneficiaries and charities? Who are the key people who will manage this process? How will assets be invested? How will beneficiaries with special needs be taken care of? 

Next, it is important to emphasize that we are at an early stage of analyzing the tax reduction planning that will be appropriate under this new Act. With that in mind, here is a list of general tax planning observations that national estate planning experts have been discussing. 

Five Year Plan. Our rule of thumb has always been that you should plan for the next five years. Then re-evaluate your situation and planning. This concept continues to be appropriate in view of uncertainties created by this new Tax Act.

Good News: Existing Tax Planning Techniques Untouched. There is always the danger that when Congress brings us a new tax benefit, it will take an existing one away. For example, see the discussion of the qualified family owned business interest deduction, above. The good news is that, for the most part, such tradeoffs did not occur in the transfer tax area. For example, the Treasury Department has been lobbying Congress to eliminate valuation discounts for transfers of passive assets between family members. Similarly, Treasury has been trying to eliminate qualified personal residence trusts and annual exclusion gifting to trusts. None of these endangered techniques were eliminated by the new Tax Act. Almost all of our other tax reduction techniques remain intact. 

Continue Planning. The phase-in of benefits, possible repeal, and potential sunsetting are a long way off. You do not want to abandon or forego valuable planning techniques only to find out that political gridlock or national economic changes result in some or all of the transfer tax benefits not occurring.  

Interim Life Insurance. If you are doing initial estate planning or re-doing your planning and the estate tax applicable credit is more than your family's total net worth (including life insurance), then you may decide not to include tax reduction planning. If you are between $675,000 and a future estate tax applicable credit amount, you may want to purchase term life insurance to cover the period between now and when the credit amount phases-in.

Review Dispositive Plans. Some plans depend upon the estate tax applicable credit amount. For example, plans which distribute that amount to children of a first marriage, and the remaining assets to a second spouse. As the credit amount increases, or is eliminated by repeal, the plan changes. Is this what you want?

Take Advantage of New Gift Tax Credit. For gift tax purposes, beginning in 2002 the applicable credit is $1,000,000. Even if you have already used your present credit ($675,000), you now have $325,000 more. In medium and large estates, both spouses should consider gifting this amount to trusts. Future growth will be excluded from your estates. The gifts may be leveraged by taking advantage of the valuation discount offered by family LLCs. The trust may be perpetual for the benefit of your children and further descendants. Alaska self-settled trusts allow you to be discretionary beneficiaries.

Avoid Paying Gift Tax. Under existing law, it is advantageous to pay gift tax rather than estate tax. However, if the estate tax is repealed, there will be no advantage in the prior payment of gift tax. When significant gifting is appropriate, we can help with planning "safety nets" which minimize the risk that such gifts will produce out-of-pocket gift tax liability.

 Perpetual Trusts. If the estate tax ultimately is repealed, experts are recommending that perpetual trusts be used to protect assets against subsequently enacted estate or inheritance taxes. 

Use Community Property Trusts. Alaska's optional community property act is designed to take advantage of the full adjustment of basis at the death of the first spouse to die. This will minimize the capital gain tax when a surviving spouse sells assets. This special community property benefit is not affected by the new Tax Act. Beginning in 2010, the proposed carryover basis will limit the adjustment of basis to a maximum of 4.3 million dollars. Our clients often use joint revocable trusts to take advantage of this income tax benefit.

We Will Keep You Informed. The tax laws have always been a "moving target." We will keep you informed of new transfer tax developments and changes. As new planning techniques develop, we will be discussing them in future newsletters and on our web page.  


Alaska Enacts Amendments to Alaska Community Property Act. In 1998, Alaska enacted an optional community property system for its residents, and for non-residents who desire to use such a system. Couples may elect to have some or all of their property characterized as community property. Residents accomplish this election by entering into a community property agreement or executing a community property trust. Non-residents may elect to have some or all of their property characterized as Alaska community property by executing a community property trust, which has at least one trustee who is an Alaska individual or an Alaska bank or trust company. 

The Alaska optional community property act provides the non-tax benefits of sharing and equality of ownership. In addition, several significant tax benefits are provided. At the death of the first spouse to die, both halves of the community property receive an adjustment in basis. As a result, if the surviving spouse sells community property, capital gain is minimized. Second, after the death of the first spouse, the ability to use non-pro rata funding of the bypass and marital share often provides advantageous income tax and property ownership benefits. 

Alaska's community property system was patterned after the Uniform Marital Property Act (UMPA), originally drafted in 1983. This Uniform Act provides a good overall structure, but has some ambiguities, and there have been significant tax developments since it was originally drafted. Amendments contained in House Bill 181, enacted by the Alaska Legislature this year, are designed to solve some of the issues and supplement gaps presented by the UMPA draft.  

1. Increased Asset Protection. The first amendment changes the portion of the community property which is subject to the claims of a creditor of only one of the spouses. If the spouses held their property jointly, but not as community property, then a creditor of only one spouse could only reach the assets of that spouse. Under the UMPA draft, an obligation incurred by a spouse during marriage is presumed to be incurred "in the interest of the marriage or the family." All of the community property is liable for such an obligation. This enlargement of the property exposed to the liability of only one spouse has caused some couples to hesitate to use this community property system. In House Bill 181, the Alaska Legislature has amended the law to provide that the creditor of only one spouse may only reach the separate property of that spouse and that debtor spouse's one-half of the community property. 

2. Transfers of Property to a Community Property Trust By Beneficiary Designation. This new provision allows property such as life insurance and IRAs to be transferred to a community property trust (thereby characterizing this property as community property) by designating the trust as the beneficiary of such property. This amendment will assist couples using joint revocable trusts, and non-residents using Alaska community property trusts, in characterizing such assets as community property. 

3. Life Insurance. This amendment focuses upon the use of community property funds for the payment of premiums on life insurance policies. A.S. 34.77.120(b)(5) is amended to create a presumption that the use of community property funds to purchase a life insurance policy for the benefit of certain family members, or a trust for those members, is presumed to be made with the consent of the other spouse. The existing statute creates such a presumption if the beneficiary is the parent or child of either spouse. The amendment expands this category to ancestors or descendants of either spouse, or a trust for the benefit of such persons. 

A new subsection (7) is added to A.S. 34.77.120(b). The purpose of this provision is to protect the spouses from undesired and unexpected federal estate tax consequences. Assume that one of the spouses forms an irrevocable life insurance trust and contributes funds to the trust so that the trustee may purchase a life insurance policy on such spouse's life. Typically such a trust will be for the benefit of the surviving spouse, and then the family's children. If the funds contributed to the trust came from a community property source, the IRS may argue that if the surviving spouse is a beneficiary of the trust, then pursuant to Internal Revenue Code Section 2036 the trust will be partially included in the surviving spouse's gross estate for federal estate tax purposes. To avoid this undesirable consequence, the amendment creates a presumption that any funds contributed to such a trust were first converted to the separate property of the insured spouse. The testimony of the spouse whose life is not insured is sufficient to rebut either of the presumptions described above. 

4. Division of Community Property at Death. This amendment clarifies that on the death of a spouse, one-half of the community property reflects the share of the decedent and the other one-half reflects the share of the surviving spouse. Further, the Alaska Legislature has adopted the aggregate form of ownership of community property. Therefore, upon the death of a spouse, a distribution of community property in kind may be made on the basis of a non-pro rata division of the aggregate value of the community property.  

The goal of this amendment is to allow for flexibility in the division of assets after the death of the first spouse. For example, a couple's assets may consist of a large qualified plan or IRA account plus an approximately equal amount of other assets. Assume that all of the assets are community property and the spouse who acquired the retirement assets dies first. A non-pro rata division of the community property on an aggregate basis would allow the retirement assets to be transferred to the surviving spouse, as his or her one-half of the community property, and the other assets to be used to fund the bypass trust created by the deceased spouse's will. Such a non-pro rata division would maximize both income tax and estate tax planning benefits. 

These community property amendments became effective as of May 8, 2001.