Education Is the Clear Winner in the New Tax Act

Article excerpt

The enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRA) accomplished sweeping changes in the three tax regimes that impact individual taxpayers: income taxes, gift taxes, and estate taxes.

The Act contained little, if any, corporate tax relief provisions. For the individual taxpayer, the income tax relief provisions provided by EGTRA include a gradual reduction relating to the tax treatment of education expenses. These are highlighted in the following article.

Introduction

Reaction to the recent Tax Act passed by Congress and now signed by the President has received somewhat mixed reviews.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRA) does little to remove many of the complexities of the income tax regime, and, in fact, it tends to add to these complexities.

The Act has some positive aspects such as reducing income tax rates for individuals as well as estate tax rates. The negative aspects of the Act relate primarily to the various sunset provisions which operate to phase out, or, more succinctly, eliminate most of the positive provisions of the legislation. Additionally, the phase out provisions of the Act make it difficult for the individual taxpayer and the tax advisor to develop a consistent financial strategy because of the uncertainty of the future income tax and estate tax provisions.

The income tax provisions create the illusion of a benefit for individual taxpayers because of the tax rate reduction. The illusion vanishes quickly, however, because the rate reduction will simply force the individual taxpayer to suffer with the tax burden of the alternative minimum tax (AMT) whereby most of the itemized deductions are lost in computing the amount of income which is subject to the AMT.

The estate tax provisions of the Act are positively ghoulish in their application. Simply stated, if an individual survives to the year 2010, the individual would not incur any estate tax notwithstanding the size of the estate at the time of the individual's death, but should the individual survive until January 1 of 2011, the estate will be subject to an estate tax with a maximum tax rate of 50%. In addition, the assets of the estate will assume a tax basis equal to the lesser of the carryover basis that the decedent had in the estate assets or the fair market value of the assets at date of death.

The present law provides that property inherited from a decedent assumes a tax basis equal to the fair market value of the asset on which the estate tax was levied. For example, if the decedent had purchased an asset, such as stock while living for a cost of $1,000, and that asset had increased in value to $4,000 in the estate of the decedent, the tax basis of the stock would be $4,000 in the hands of the party receiving the stock as an heir of the decedent This increased tax basis is important since the increased basis would reduce the amount of taxable gain on a subsequent sale of the stock.

The effect of the new law would require that the tax basis of the inherited property be the lower of the price initially paid for the asset or the fair market value of the asset on which the estate tax was levied.

In the example above, the basis of the asset under the new law would be $1,000. This would operate to increase the amount of taxable gain on a subsequent sale of the asset Additionally, this provision would require significant, detailed record keeping in order to determine the original cost of the asset Thankfully this provision is not due to take effect until the year 2010 when the estate tax is scheduled to be repealed.

These provisions for determining the tax basis of the assets in the estate are much more onerous than the current provisions. 'Without expanding on all the aspects of these provisions suffice it to say that for the moment it is better to die in the year 2010 than it is to survive until the year 2011. …