The Tax Relief Act of 2010 expired December 31, 2012, and we are now operating under the framework of the American Taxpayer Relief Act. In this letter, since we are now in 2013, I want to outline these changes and highlight possible planning opportunities which are important for you to consider this year.
Recent History. The “Bush era tax cuts” phased in a decade of change in the estate tax arena. Before the Bush era, we had an estate tax structure that protected $675,000 from the estate tax for each individual, with a maximum tax rate of 55% on amounts above $675,000. By 2009, the protected amount had increased to $3 .5 million and the maximum rate was reduced to 45%. Calendar year 2010 was a year of total confusion due to the lack of any coherent tax planning by Congress. In 2010, we actually had a year in which there was no federal estate tax.
As we looked to 201 I, we feared that inaction by Congress would result in the reinstatement of existing pre-Bush era law. That would have dropped the protected amount back down to $1 million and increased the maximum tax rate (for amounts above that $1 million figure) to 55%. That default option would have been disastrous for many of us .. The Tax Relief Act 0[201 a prevented this from occurring and reinstated the concept of an estate tax credit and the unlimited marital deduction on assets being transferred to or for the benefit of the surviving spouse. The applicable exclusion amount was $5 million per person and a combined $10 million per married couple. The estate tax above these amounts was a flat 35% tax rate. This structure had both the highest amount protected by the estate tax credit and the lowest maximum estate tax rate in recent history! The applicable exclusion amount was indexed for inflation beginning in 2012.
We now know what will happen in the future. Teetering on the brink of the “fiscal cliff,” Congress finally voted to come to a partial compromise. About two hours into the New Year in Washington, the Senate voted 89-8 to pass H.R. 8, the “American Taxpayer Relief Act.” Late into the evening of the same day (January 1, 20]3) the House of Representatives followed suit and voted 257-167 to pass the measure. President Obama signed the legislation.
Discussion of the Estate Tax Law under the “American Taxpayer Relief Act. The following is a brief review of the significant provisions of the new Act. From an estate tax perspective, the measure makes permanent all of the provisions of Tax Reform Act of 2010, except the rate. This means the first $5 million of an estate, adjusted for inflation, is excluded from the estate tax. Thus, for 20 13, the inflation-adjusted exclusion is $5.25 million. This is “unified” or combined with the gift tax and may be used at death or during lifetime, with lifetime use subtracted from the amount remaining for use at death. In effect, this allows a person to make gifts during life and bequests through a will totaling $5.25 million without incurring an estate tax. The tax rate on amounts above this amount is capped at 40% rather than the 35% provided in prior law.
Lifetime gifts can be common source of confusion. An individual can each give another person $14.000.00 per year without it counting against the lifetime exemption. (The amount went up at the end of 2012.) Spouses can combine this annual exclusion to double the size of the gift. Don’t confuse it with the basic exclusion-that $5.22 million discussed above. The $14,000 per year gift can be made in addition to that amount without incurring a tax.
For example this year, relying on the annual exclusion, a married couple with a child who is married and has two children could make a joint cash gift of $28,000.00 to the adult child, the child’s spouse and each grandchild-four people-providing the family with $112.000.00 a year. Only gifts that exceed the limit count against the lifetime exclusion The “portability” provision is similarly retained by the new law. This provision is a significant benefit for married couples. It states the exclusion amount of the first spouse to die may be used by the surviving spouse, assuming an estate tax return is filed after the death of the first spouse.
The Generation Skipping Tax (which commonly applies to gifts to grandchildren) also has an exemption that is set at an inflation-adjusted $5 million. However, as with prior law, GST exemption is not portable. Thus, in order to preserve the GST exemption of the first spouse to die, the use of a credit shelter trust is needed. Of course, the use of a credit shelter trust is also advisable to provide remarriage protection and other benefits.
The simplest way to use the annual exclusion is to give cash or other assets each year to each of as many individuals as you want. Another possibility is to put money in Section 529 education savings plans. Establishing these plans for relatives could relieve siblings or children of the need to save for college at a time when they are overwhelmed with current expenses.
On the income tax side, the tax rates on income below $400,000 for single filers or $450,000 for married filing jointly have been made permanent at their current level. The tax rate for income above that level will rise from 35% to 39.6%, the rate pre-2001. Further, qualified dividend and capital gain income tax rates will be going up from 15% to 20% for that same group but will remain at their current levels for those with income below that amount.
The “charitable rollover” IRA provisions have been extended for years 2012 and 2013 only. Thus, an individual over age 70 ~ can give up to $100,000 from an IRA without taking the amount into income. This can be important for some taxpayers because the charitable deduction otherwise may be capped or not fully offset the income.
Impact on You. These estate tax law changes will impact the tax planning of every individual’s estate plan.
It is, of course, not possible to draw individual conclusions or make individual recommendations in this letter. For some individuals and couples, the tax issues surrounding estate planning may no longer be the primary factor that dictates the structure of their estate planning documents. In fact, the protected amount ($5.25 million per person and a combined $1 0.50 million per couple) may warrant a change to many estate plans currently in place. For example, using a default allocation formula might leave too much of the family wealth to one part of the family and too little of the wealth to another part of the family.
For other individuals and couples, tax-oriented estate planning will remain a significant component of the estate planning discussion.
In all cases, it is important to remember that estate planning is not just about tax planning. Your estate planning documents must be designed to work for you and your family. Each family has unique needs, challenges, and sometimes … problems. Important questions include: How and when will you make distributions to family members? Who will be the personal representative (executor) and trustee? What are the needs of your children, grandchildren, or other family members? Should all children be treated equally or are the needs of the children different? To create an effective estate plan, proper estate planning documents must address these types of family issues.
Similarly, even if there is no estate tax impact on you and your family, there is still the cost in time and expense of going through the probate process. For this reason alone, the use of a revocable trust as the principal document in most estate plans (and actually transferring your assets into the trust!) is critical.
We are available to assist you with these important planning matters. Please contact the office to set up an appointment.
Dalton B. Floyd, Jr., Esquire
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