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THE FISCAL CLIFF DEAL AND ESTATE PLANNING
The impact of the Fiscal Cliff deal (the “Deal”) on income taxes, especially for those persons in the highest tax bracket, has been well-documented. What has scarcely been noticed, however, is the continuation of the government’s favorable treatment toward estate and gift taxes on large estates.
This article will review the portions of the Deal affecting estate taxes, gift taxes and generation-skipping taxes, and discuss how these rules create continued opportunities for individuals looking to freeze or lower their taxable estates.
New Estate Tax Laws
|
|
2012 Law |
Old 2013 Law |
New 2013 Law |
|
Estate Tax Exemption |
$5,120,000 |
$1,000,000 |
$5,250,000 |
|
Gift
Tax Exemption |
$5,120,000 |
$1,000,000 |
$5,250,000 |
|
Generation Skipping Tax
Exemption |
$5,120,000 |
$1,000,000 |
$5,250,000 |
|
Estate Tax Rate |
35% |
35%
- 55% |
40% |
|
Portability |
Yes |
No |
Yes |
As you can see from above, the estate and gift tax exemptions remain at $5 million per person. To be exact, the number is $5,250,000 in 2013, and will be adjusted for inflation each year.
This means that a person may transfer, during life or upon death, up to $5,250,000 ($10,500,000 for married couples) to his or her beneficiaries without paying any transfer taxes.
The tax rate on amounts transferred above the estate, gift or generation-skipping tax exemption was 35% in 2012. The Deal raised the tax rate to 40% on amounts above the exemption.
The law in 2011 and 2012 also allowed for “Portability”, which is the ability of an individual to use his or her deceased spouse’s unused estate tax exemption. The Portability provisions have all been continued under the
new law.
This means that when the second of two spouses dies, she will have her own estate tax exemption plus any portion of her spouse’s unused exemption.
For example, if a couple has $8 million of community property assets, and husband gives his $4 million to his spouse at his death, none of his exemption is used since the transfer qualifies for the marital deduction. Upon the spouse’s death, she now owns $8 million in assets and would have to pay an estate tax on the amounts above her estate tax exemption of $5.25 million. With portability, however, she can add her husband’s unused $5 million exemption to her own exemption, which gives her a total estate exemption of $10.5 million, and no estate taxes will be due.
Remember that portability is not automatic; you must file an estate tax return upon the first spouse’s death to make his or her exemption portable, even if that person would not have otherwise been required to do so.
While some people will say that portability negates the need for creating a bypass trust at the first spouse’s death, this is not correct. Creating a bypass trust gives the surviving spouse protection from creditors and lawsuits, and allows for the preservation of the deceased spouse’s generation-skipping tax exemption, which is not portable.
Estate Planning Tools that Remain Available
The Deal did not address the following issues:
- Minimum terms for grantor retained annuity trusts
- Elimination of valuation discounts on transfers between family members
- Limits on the term of generation-skipping trusts
- Elimination of intentionally defective grantor trusts (IDGTs), which allow a grantor to transfer assets for estate tax purposes while continuing to effectively receive income from the assets transferred
Taken together with the $5.25 million estate and gift tax exemption amounts, these and other tools will continue to be used in 2013 until Congress changes the law.
While there is no expiration date written into the new law, the exemption amounts or the estate tax planning tools can be changed through the passage of a new law at any time. Because the estate and gift tax laws were not negotiated very much as part of the Deal, we expect them to be part of a more extensive negotiation in the coming months, with the possibility that some or all of the above strategies could be lost.
For those individuals who made transfers under the Fiscal Cliff deadline, they should not be discouraged. It’s important to remember that the earlier the planning begins, the more effective it will be at reducing estate tax liability, since all appreciation of transferred assets occurs outside of the grantor’s estate.
The Fiscal Cliff helped many individuals make advantageous tax planning moves that they may not have otherwise done, and the benefits to their families will continue to compound over time. For those people who did not act, the opportunity remains; for how long, we don’t know. |
