The American Taxpayer Relief Act of 2012 (the “Act”), which includes a variety of changes to the Internal Revenue Code, will affect most American taxpayers. In this article, we will address the key estate tax, gift tax and generation-skipping transfer (GST) tax elements of the legislation.
Prior to passage of the Act, the federal estate tax, gift tax and GST tax laws were scheduled to change dramatically as of January 1, 2013. For example, although the gift tax exemption was $5,120,000 in 2012, it was scheduled to be reduced to $1,000,000 in 2013. The gift tax rate (for amounts above the exemption) was a flat 35% in 2012, but was scheduled to revert to a graduated tax with a top rate of 55% in 2013. Similar changes were in store for the estate tax and the GST tax. The combination of reduced exemptions and increased rates would have substantially increased the amount of transfer tax many of our clients or their estates would pay.
The potential for such dramatic increases in 2013 was the primary impetus for some of our clients to make significant gifts prior to the end of 2012. Those gifts continue to constitute good estate planning, even though the tax increases have been averted, because lifetime gifts move future income and appreciation in the gifted assets out of the donor’s estate and also reduce the state estate tax that otherwise might be payable at the donor’s death. Also, we note that there may be future decreases in the estate tax exemption or increases in the tax rate. Finally, in some cases, the retained obligation of the donor to pay income tax on the taxable income of the gifted assets (through the use of a grantor trust) can further increase the benefit to the recipient and reduce the taxable estate of the donor.
The Act made permanent the 2012 estate, gift and GST laws, with only a few changes. The $5,000,000 estate tax, gift tax and GST tax exemption was retained and will continue to be inflation-adjusted. For 2013, those exemptions are $5,250,000, an increase of $130,000 over the 2012 exemptions of $5,120,000. The tax rate on estates, gifts and GST transfers above the exemption was increased to 40%, from the 35% rate in effect in 2012.
The so-called “portability” rules that simplify the use of the estate tax exemption for married clients were scheduled to expire in 2013 but have been extended under the Act. These rules permit the estate of the second spouse to die to use the unused estate tax exemption of the estate of the first spouse to die, thus avoiding the possibility of wasting a portion of the couple’s combined exemptions.
Finally, although not part of the Act, the annual exclusion amount for 2013 is $14,000 (up from $13,000 in 2012). This is the maximum amount that an individual can give to a beneficiary in a calendar year without using gift tax exemption or paying gift tax. The annual exclusion is subject to inflation-adjusted increases in $1,000 increments in future years.
The Act’s rules regarding the estate tax, gift tax and GST tax are “permanent”, meaning that they are not subject to phase-outs or other built-in modifications, but time will tell whether they are truly permanent. President Obama’s administration has proposed various changes to the rules pertaining to certain estate planning transactions, so it is certainly possible that there will be revisions to the estate, gift and GST tax laws in the future.
You may wish to consider how the new law affects your estate planning. Those who made gifts in 2012 or before may wish to consider “topping off” the gifts to use the $130,000 increases in the gift tax and GST tax exemptions. Some who did not make gifts may wish to reevaluate the benefits of making significant gifts. If you have postponed a review of your estate plan pending the outcome of tax legislation, this may be a good time to review your plan.
If you have questions about the impact of the new law on your estate planning, please feel free to contact any member of our Estate Planning and Administration Group.