Victims of Terrorism Tax Relief Act of 2001

On Jan. 23, 2002, President Bush signed into law the Victims of Terrorism Tax Relief Act of 2001 (the Act). This Act provides both income and estate tax benefits for covered individuals. The Act extends the benefits currently offered to military personnel and government employees who die as a result of combat or terrorism abroad to all covered terrorism victims. The Act also expands the type of benefits offered.

Although certain inconsistencies in the definition of "specified terrorist victims" exist in the income and estate tax provisions, individuals covered by the Act are those who died as a result of wounds or injuries suffered because of the terrorist attacks against the U.S. on April 19, 1995 (the Oklahoma City bombing) or Sept. 11, 2001 (including the attacks on the World Trade Center and the Pentagon, and the crash of United Airlines Flight number 93). The Act also extends relief to those who died as a result of illness from a terrorist attack involving anthrax, which occurred between Sept. 11, 2001Jan. 1, 2002. The IRS issued Pub. 3920, Tax Relief for Victims of Terrorist Attacks, which gives guidance and detailed instructions on filing claims for relief.

Income Tax Relief

For specified terrorist victims (but not their spouses), the Act waives taxes for the year of death and for any prior tax year in the period beginning with the last tax year ending before the year in which the victim sustained wounds (new Sec. 692(d)(1)). Anyone who died in 2001 as a result of the terrorist attacks does not owe any taxes for the 2000 or 2001 tax years. Under this new provision, an income tax waiver may apply for more than the two years. For example, if injuries were sustained in 2001 due to a terrorist attack, but death did not occur from those injuries until 2002, tax relief would be available for 2000, 2001 and 2002. Taxpayers will have to file amended tax returns for the 2000 tax year or any affected year for which they have already filed returns.

Taxes will, however, continue to apply to certain income received by a specified terrorist victim. Deferred compensation that a victim would have received if he had died in some other manner would still be subject to tax. Additionally, if an action taken after Sept. 11, 2001 causes an acceleration of income (e.g., withdrawals from retirement plans and income received as a result of adjustments the decedent's employer made to a plan or arrangement that accelerated the vesting of restricted property), the income will not be exempt from tax.

If under the above rules, the total refunds received for the tax waiver do not equal at least $10,000, the victim would be deemed to have paid $10,000 against the tax (i.e., as an estimate), and the government will refund at least $10,000 to each victim (new Sec. 692(d)(2)).

Individuals must file all refund claims for 2000 within the appropriate time period. Surviving spouses or executors of victims of the September 11 attacks may claim relief for 2001 when filing a decedent's income tax return and an estate's fiduciary income tax return. Survivors or executors of those killed in the Oklahoma City attack have until Jan. 23, 2003 to file amended returns for 1994 and 1995.

Any returns filed under the new law should have "KITA" (Killed in Terrorist Action) and either "Oklahoma City," "9/11" or "Anthrax" written at the top of the return. These returns should be filed at a central location in Massachusetts.

Estate Tax Relief

For estate tax relief, individuals can use a reduced rate table. The unified credit (UC) remains unchanged for this purpose, but it shelters far more than the $675,000 (for 2001) it does for persons other than terrorist victims. The interaction between the reduced-rate table, the state death-tax credit and the UC serves to protect even a very large estate from Federal estate tax.

The highest rate under the reduced rate table is 20%; it does not apply until a taxable estate exceeds $10.1 million. In contrast, for persons dying in 2001, the top rate of 55% was reached once a taxable estate exceeded $3 million.

Example: V died in the terrorist attack on the World Trade Center in 2001. His taxable estate was $9,000,000. The tax would be calculated as follows:

Individuals need to exercise care in interpreting will provisions. Many standard credit-shelter provisions might have unintended results, especially if the will leaves "the maximum amount that can pass free of federal tax after taking into account the unified credit and the state death tax credit." For covered individuals, the maximum amount that can pass tax-free using both the UC and the state death-tax credit is $8,762,500.

The use of the reduced rate table is elective. As can be seen in the example, very large amounts can now pass tax free. Executors may have to carefully examine the effects of making this election. The use of disclaimers either to achieve (or perhaps to avoid) this result may increase. (For more information, see DiRe, Sawyers, Sullivan and Westort, "New Law Offers Relief to Terrorists-Attack Victims, p. 313, this issue.)

From Randi A. Schuster, J.D., LL.M., New York, NY