Estate Taxes Will Turn
Sharply Lower on Jan. 1

Here's an important estate-tax tip for tens of thousands of America's wealthiest people: Keep inhaling at least until New Year's Day.

If you manage to survive until 2004, your heirs should be extremely grateful. Sharply lower estate taxes are coming.

Here's how it works: The basic estate-tax exclusion will jump 50% to $1.5 million on Jan. 1 from $1 million today. Thus, the first $1.5 million bequeathed to someone, other than your spouse, typically will be free and clear of federal estate taxes. (In most cases, you can leave everything to your spouse free of estate tax.)

At the same time, the top estate-tax rate, now 49%, will edge down to 48% on Jan. 1, under legislation signed by President Bush in 2001.

The tax savings will be very large. But if you're in line to inherit a fortune, don't spend it all immediately. Many revenue-starved states, such as New York, have greatly increased their own take -- which can take a significant bite out of those hefty savings, warns Peter C. Valente, a lawyer at Blank Rome LLP in New York City.

There are other reasons to be cautious: Congress probably will make important changes in the law in coming years. Thus, many wealthy people -- and their heirs -- should take a fresh look at current law and consider ways to reduce Uncle Sam's still-fierce tax bite.

Under the law as it now stands, the basic estate-tax exclusion is scheduled to remain $1.5 million in 2004 and 2005. Then, it's set to rise to $2 million in 2006, 2007 and 2008 and $3.5 million in 2009. The tax is scheduled to disappear entirely in 2010, but only for that one year. (That's why tax lawyers quip there may be an unusually high death rate among the ultrarich in 2010.) It's set to spring back to life again in 2011 -- with a $1 million exclusion.

The top estate-tax rate is scheduled to continue dropping. Based on current law, the top estate-tax rate will decline to 47% in 2005, 46% in 2006 and 45% in 2007 through 2009. In 2010, the estate tax will be zero, only to spring back to life again in 2011 with a 55% rate on the largest estates, according to an Ernst & Young tax book.

One way to trim your taxable estate is to take advantage of the $11,000-a-year gift-tax exclusion. That means you can give away as much as $11,000 a year to anyone you want, and to as many people as you wish, without having to worry about estate or gift taxes. There's no limit on the total amount you can give away. And the recipient doesn't even have to be related to you.

If you want to give away more than that, pay someone else's medical or education bills. Those payments won't count toward the annual limit. Be sure, though, to make those payments directly to the educational or medical institutions, rather than handing over the money to your children or grandchildren and telling them to pay the bills.

Many lawmakers and Bush administration leaders continue to lobby for complete repeal of what they refer to as "death taxes." At a recent meeting to build support for repeal, Treasury Secretary John Snow said "the death tax is simply unfair and wrong. It's antisavings, antifamily, and anti-small-business. It needs to end."

One possible compromise: Raise the exclusion even further -- but leave the tax in place for the super-rich. Senate Minority Leader Tom Daschle told me that he supports phasing in an increase in the exclusion to $4 million per person. He reiterated his opposition to permanent repeal.

"I'm always hopeful for a compromise" solution, said Sen. Daschle, a South Dakota Democrat who is up for re-election next year.