F. Amendments to Title V of the 1997 Act Relating to Estate and Gift Taxes

1. Clarification of phaseout range for 5-percent surtax to phase out the benefits of the unified credit and graduated rates (Sec. 6007(a)(1) of the bill, Sec. 501 of the 1997 Act, and Sec. 2001(c)(2) of the Code)

Present Law

Prior to the 1997 Act, a 5-percent surtax was imposed upon cumulative taxable transfers between $10 million and $21,040,000 to phase out the benefits of the graduated rates and the unified credit. The 1997 Act increased the unified credit beginning in 1998, from an effective exemption of $600,000 to an effective exemption of $1,000,000 in 2006. A conforming amendment was made to the 5-percent surtax provision in section 2001(c)(2) that was intended to reflect the increased unified credit. However, the conforming amendment was drafted in a manner that had the effect of phasing out the benefits of the graduated rates but not the unified credit.

Explanation of Provision

The provision clarifies section 2001(c)(2) to properly phase out the benefits of both the graduated rates and the unified credit.

Effective Date

The provision is effective for decedents dying, and gifts made, after December 31, 1997.

2. Clarification of effective date for indexing of generation-skipping exemption (Sec. 6007(a)(2) of the bill, Secs. 501(d) and (f) of the 1997 Act, and Sec. 2631(c) of the Code)

Present Law

The 1997 Act provided for the indexation of the $1 million exemption from generation skipping transfers effective for decedents dying after December 31, 1998.

Explanation of Provision

The provision clarifies that the indexing of the exemption from generation-skipping transfers is effective with respect to all generation-skipping transfers (i.e., direct skips, taxable terminations, and taxable distributions) made after 1998.

With respect to existing trusts, transferors are permitted to make a late allocation of any additional GST exemption amount attributable to indexing adjustments in accordance with the present-law rules applicable to late allocations as set forth in sections 2632 and 2642, and the regulations promulgated thereunder. For example, assume an individual transferred $2 million to a trust in 1995, and allocated his entire $1 million GST exemption to the trust at that time (resulting in an inclusion ratio of .50). Assume further that in 2001, the GST exemption has increased to $1,100,000 as the result of indexing, and that the value of the trust assets is now $3 million. If the individual is still alive in 2001, he is permitted to make a late allocation of $100,000 of GST exemption to the trust, resulting in a new inclusion ratio of 1-(($1,500,000+100,000)/$3,000,000), or .467.

Effective Date

The provision is effective for generation-skipping transfers (i.e., direct skips, taxable terminations, and taxable distributions) made after December 31, 1998.

3. Conversion of qualified family-owned business exclusion into a deduction (Sec. 6007(b)(1)(A) of the bill, Sec. 502 of the 1997 Act, and redesignated Sec. 2057 of the Code)

Present Law

The qualified family-owned business provision in the 1997 Act provides an exclusion from estate taxes for certain qualified family-owned business interests. It is unclear whether the provision provides an exclusion of value or an exclusion of property from the estate, and thus it is unclear how the new provision interacts with other provisions in the Internal Revenue Code (e.g., Secs. 1014, 2032A, 2056, 2612, and 6166).

Explanation of Provision

The provision converts the qualified family-owned business exclusion into a deduction, and redesignates section 2033A as section 2057. Except as provided below, the requirements of the qualified family-owned business provision otherwise remain unchanged. The qualified family owned business deduction is not available for generation-skipping transfer tax purposes.

Effective Date

The provision is effective with respect to estates of decedents dying after December 31, 1997.

4. Coordination between unified credit and family-owned business provision (Sec. 6007(b)(1)(B) and 6007(b)(4) of the bill, Sec. 502 of the 1997 Act, and redesignated Sec. 2057(a) of the Code)

Present Law

The 1997 Act effectively increased the amount of lifetime gifts and transfers at death that are exempt from unified estate and gift tax from $600,000 to $1,000,000 over the period 1997 to 2006, through increases in an individual's unified credit. in addition, the 1997 Act provided a limited exclusion for certain family-owned business interests. The exclusion for family-owned business interests may be taken only to the extent that the exclusion for family-owned business interests, plus the amount effectively exempted by the unified credit, does not exceed $1.3 million. As a result, for years after 1998, the maximum amount of exclusion for family-owned business interests is reduced by increases in the dollar amount of transfers effectively exempted through the unified credit.

Because the structure of the 1997 Act increases the unified credit over time (until 2006) while decreasing over the same period the benefit of the closely-held business exclusion, the estate tax on estates with family-owned businesses increases over time until 2006. This increase in estate tax results from the fact that increases in the unified credit provide a benefit at the decedent's lowest estate tax brackets, while the exclusion for family-owned businesses provides a benefit at the decedent's highest estate tax brackets.

Explanation of Provision

Under the provision, if an executor elects to utilize the qualified family-owned business deduction, the estate tax liability is calculated as if the estate were allowed a maximum qualified family-owned business deduction of $675,000 and an applicable exclusion amount under section 2010 (i.e., the amount exempted by the unified credit) of $625,000, regardless of the year in which the decedent dies. If the estate includes less than $675,000 of qualified family-owned business interests, the applicable exclusion amount is increased on a dollar-for-dollar basis, but only up to the applicable exclusion amount generally available for the year of death.

For example, assume the decedent dies in 2005, when the applicable exclusion amount under section 2010 is $800,000. If the estate includes qualified family-owned business interests valued at $675,000 or more, the estate tax liability is calculated as if the estate were allowed a qualified family-owned business deduction of $675,000, and the applicable exclusion amount under section 2010 is limited to $625,000. If the estate includes qualified family-owned business interests of $500,000 or less, all of the qualified family-owned business interests could be deducted from the estate, and the applicable exclusion amount under section 2010 is $800,000. If the estate includes qualified family-owned business interests valued between $500,000 and $675,000, all of the qualified family-owned business interests could be deducted from the estate, and the applicable exclusion amount under section 2010 is calculated as the excess of $1.3 million over the amount of qualified family-owned business interests. (For example, if the qualified family-owned business interests were valued at $600,000, the applicable exclusion amount under section 2010 is $700,000.)

If a recapture event occurs with respect to any qualified family-owned business interest, the total amount of estate taxes potentially subject to recapture is calculated as the difference between the actual amount of estate tax liability for the estate, and the amount of estate taxes that would have been owed had the qualified family-owned business election not been made.

Effective Date

The provision is effective for decedents dying after December 31, 1997.

5. Clarification of businesses eligible for family-owned business provision (Sec. 6007(b)(2) of the bill, Sec. 502 of the 1997 Act, and redesignated Sec. 2057(b)(3) of the Code)

Present Law

In order to be eligible to exclude from the gross estate a portion of the value of a family owned business, the sum of (1) the adjusted value of family-owned business interests includible in the decedent's estate, and (2) the amount of gifts of family-owned business interests to family members of the decedent that are not included in the decedent's gross estate, must exceed 50 percent of the decedent's adjusted gross estate.

Explanation of Provision

The provision clarifies the formula for determining the amount of gifts of family-owned business interests made to members of the decedent's family that are not otherwise includible in the decedent's gross estate.

Effective Date

The provision is effective with respect to decedents dying after December 31, 1997.

6. Clarification of "trade or business" requirement for family-owned business provision (Sec. 6007(b)(5) of the bill, Sec. 502 of the Act, and redesignated Secs. 2057(e)(1) and 2057(f) of the Code)

Present Law

A qualified family-owned business interest is defined as any interest in a trade or business that meets certain requirements--e.g., the decedent and members of his family must own certain percentages of the trade or business, the decedent or members of his family must have materially participated in the trade or business for five of the eight years preceding the decedent's death, and the qualified heir or members of his family must materially participate in the trade or business for at least five years of any eight-year period within 10 years following the decedent's death.

Explanation of Provision

The provision clarifies that an individual's interest in property used in a trade or business may qualify for the qualified family-owned business provision as long as such property is used in a trade or business by the individual or a member of the individual's family. Thus, for example, if a brother and sister inherit farmland upon their father's death, and the sister cash-leases her portion to her brother, who is engaged in the trade or business of farming, the "trade or business" requirement is satisfied with respect to both the brother and the sister. Similarly, if a father cash leases farmland to his son, and the son materially participates in the trade or business of farming the land for at least five of the eight years preceding his father's death, the pre-death material participation and "trade or business" requirements are satisfied with respect to the father's interest in the farm.

Effective Date

The provision is effective with respect to estates of decedents dying after December 31, 1997.

7. Clarification that interests eligible for family-owned business provision must be passed to a qualified heir (Secs. 6007(b)(1)(B) of the bill, Sec. 502 of the Act, and redesignated Sec. 2057(a)(1) of the Code)

Present Law

The 1997 Act provided a new exclusion for qualified family-owned business interests. One of the requirements for the exclusion is that such interests must pass to a "qualified heir," which includes members of the decedent's family and any individual who has been actively employed by the trade or business for at least 10 years prior to the date of the decedent's death.

Explanation of Provision

The provision clarifies that qualified family-owned business interests must pass to a qualified heir in order to qualify for the deduction. For this purpose, if all beneficiaries of a trust are qualified heirs (and in such other circumstances as the Secretary of the Treasury may provide), property passing to the trust may be treated as having passed to a qualified heir.

Effective Date

The provision is effective with respect to estates of decedents dying after December 31, 1997.

8. Other modifications to the qualified family-owned business provision (Secs. 6007(b)(3), 6007(b)(6), and 6007(b)(7) of the bill, Sec. 502 of the 1997 Act, and redesignated Sec. 2057 of the Code)

Present Law

The qualified family-owned business provision incorporates by cross-reference several other provisions of the Code, including a number of provisions in section 2032A and the personal holding company rules of section 543(a).

Explanation of Provision

The provision modifies section 2033A(g) (relating to the security requirements for noncitizen qualified heirs) by deleting the cross-reference to section 2033A(i)(3)(M), which does not appear to be appropriate. The provision also makes rules similar to those set forth in section 2032A(h) and (i) (relating to conversions and exchanges of property under sections 1031 and 1033) applicable for purposes of section 2033A. Finally, the provision clarifies that, in identifying assets that produce (or are held for the production of) income of a type described in section 543(a), section 543(a) is applied without regard to section 543(a)(2)(B) (the dividend requirement for corporate entities).

Effective Date

The provision is effective with respect to estates of decedents dying after December 31, 1997.

9. Clarification of interest on installment payment of estate tax on holding companies (Sec. 6007(c) of the bill, Sec. 503 of the 1997 Act, and Secs. 6166(b)(7)(A) and 6166(b)(8)(A) of the Code)

Present Law

If certain conditions are met, a decedent's estate may elect to pay the estate tax attributable to certain closely-held businesses over a 14-year period. The 1997 Act provided for a 2-percent interest rate on the estate tax on first $1 million in value of interests in qualified closely-held businesses, and a rate equal to 45 percent of the regular deficiency rate on the amount in excess of the portion eligible for the 2-percent rate, but also provided that none of interest on the deferred payment of estate taxes is deductible for income or estate tax purposes. Interests in holding companies and non-readily-tradeable business interests are not eligible for the 2-percent rate.

Explanation of Provision

The provision clarifies that deferred payments of estate tax on holding companies and non readily-tradable business interests do not qualify for the 2-percent interest rate, but instead are subject to a rate of 45 percent of the regular deficiency rate. Such interest payments are not deductible for income or estate tax purposes.

Effective Date

The provision generally is effective for decedents dying after December 31, 1997.

10. Clarification on declaratory judgment jurisdiction of U.S. Tax Court regarding installment payment of estate tax (Sec. 6007(d) of the bill, Sec. 505 of the 1997 Act, and Sec. 7479(a) of the Code)

Present Law

If certain conditions are met, a decedent's estate may elect to pay estate tax attributable to certain closely-held business over a 14-year period. The 1997 Act provided that the U.S. Tax Court would have jurisdiction to determine whether the estate of a decedent qualifies for the 14 year installment payment of estate tax.

Explanation of Provision

The provision clarifies that the jurisdiction of the U.S. Tax Court to determine whether an estate qualifies for installment payment of estate tax on closely-held businesses extends to determining which businesses in an estate are eligible for the deferral.

Effective Date

The provision is effective for decedents dying after the date of enactment of the 1997 Act.

11. Clarification of rules governing revaluation of gifts (Sec. 6007(e) of the bill, Sec. 506 of the 1997 Act, and Sec. 2504(c) of the Code)

Present Law

The valuation of a gift becomes final for gift tax purposes after the statute of limitations on any gift tax assessed or paid has expired. The 1997 Act extended that rule to apply for estate tax purposes, provided for a lengthened statute of limitations for gift tax purposes if certain information is not disclosed with the gift tax return, and provided jurisdiction to the U.S. Tax Court to determine the value of any gift.

Explanation of Provision

The provision clarifies that in determining the amount of taxable gifts made in preceding calendar periods, the value of prior gifts is the value of such gifts as finally determined, even if no gift tax was assessed or paid on that gift. For this purpose, final determinations include, e.g., the value reported on the gift tax return (if not challenged by the IRS prior to the expiration of the statute of limitations), the value determined by the IRS (if not challenged in court by the taxpayer), the value determined by the courts, or the value agreed to by the IRS and the taxpayer in a settlement agreement.

Effective Date

The provision is effective with respect to gifts made after the date of enactment of the 1997 Act.

12. Clarification with respect to post-mortem conservation easements (Sec. 6007(g) of the bill, Sec. 506 of the 1997 Act, and Sec. 2031(c) of the Code)

Present Law

A deduction is allowed for estate tax purposes for a contribution of a qualified real property interest to a charity (or other qualified organization) exclusively for conservation purposes (Sec. 2055(f)). The 1997 Act also provided an election to exclude from the taxable estate 40 percent of the value of any land subject to a qualified conservation easement that meets certain requirements. The 1997 Act provided that the executor of the decedent's estate, or the trustee of a trust holding the land, could grant a qualifying easement after the decedent's death, as long as the easement is granted prior to the date of the election (generally, within nine months after the date of the decedent's death).

Explanation of Provision

The provision clarifies that, in the case of a qualified conservation contribution made after the date of the decedent's death, an estate tax deduction is allowed under section 2055(f). However, no income tax deduction is allowed to the estate or the qualified heirs with respect to such post-mortem conservation easements.

Effective Date

The provision is effective with respect to estates of decedents dying after December 31, 1997.