Important Estate Planning Law Changes – The American Taxpayer Relief Act

Happy New Year! As you know, Congress celebrated the new year by stepping out with some new tax legislation in response to the 2012 “fiscal cliff.” This tax legislation, known as the “American Taxpayer Relief Act,” was signed into law by President Obama on January 2, 2013. The historical uncertainties experienced over the past several years in the field of estate planning as a result of the changing estate and gift tax exemption and the scheduled ends of the previous laws have now been replaced with more permanent federal estate and gift tax legislation.

The good news is that things have not changed too substantially from what was in place for 2012. So for those of you who did not make the mad dash to leverage your $5,000,000 gifting exemption from last year by December 31, you are still in the game for planning purposes to take advantage of the higher exemption for future gifting. The following is a brief review of the significant changes made to estate and gift taxes in 2013:

Estate Tax. The American Taxpayer Relief Act has indexed the federal estate tax exemption for inflation, thereby setting the exemption at $5,250,000 in 2013, and a combined $10,500,000 per couple. The estate tax above these amounts is a flat 40% tax rate, up from 35% last year. This structure has the highest amount protected by the estate tax credit in recent history. As before, the gift tax and the estate tax remain totally unified and will continue to be indexed for inflation in the future, unless the law is changed.

Generation-Skipping Transfer Tax. The generation-skipping transfer tax is an entirely separate transfer tax that applies to transfers to grandchildren and younger generations. The new law indexes the generation-skipping transfer tax for inflation, with an exemption on the first $5,250,000 worth of transfers to grandchildren, and a rate of 40% on transfers to a skipped generation above that excluded amount. Since the generation-skipping tax can be a duplicative tax on top of an estate tax, care must be taken to avoid this double taxation.

Gift Tax. The annual gift tax exclusion is now $14,000 per donor to each donee in 2013. In addition, you can directly pay for tuition and medical expenses without that type of payment being deemed as a gift. All other types of gifts above $14,000 are taxable gifts. The lifetime gift tax exemption was also indexed for inflation and therefore increased to $5,250,000. The maximum gift tax rate has increased from 35% last year to 40% this year. That means that you can make up to $5,250,000 in lifetime taxable gifts ($10,500,000 per couple) before paying a tax. Taxable gifts above $5,250,000 ($10,500,000 for a couple) will be subject to a 40% gift tax rate.

Portability of Unused Exemption. Under the prior law, couples needed to establish a trust at the first death (to benefit the surviving spouse) in order to fully utilize both spouse’s credits. Some people viewed this as an unnecessary and complicated estate planning requirement just to allow the couple to claim their combined entire exemption. The “portability” option implemented in the Tax Relief Act of 2010 has now been made permanent in the American Taxpayer Relief Act, and allows the personal representative of a predeceased spouse’s estate to transfer assets and any unused estate tax credit to the surviving spouse without such planning. That means that moving forward a married couple can pass on $10,500,000 to their heirs free from federal estate taxes without any planning at all. An important note to keep in mind, though, is that even if the deceased spouse’s estate is less than $5,250,000, the surviving spouse will have to file a Form 706 Estate Tax Return in order to take advantage of the deceased spouse’s unused estate tax exemption. Otherwise, the deceased spouse’s exemption will be lost. Also, portability was not extended to the generation-skipping tax exemption, so for those who need to use both spouse’s generation-skipping tax exemptions, additional planning will be necessary.

The “Pick Up Tax.” The “pick up tax” was a state estate tax that was equal to a portion of the federal estate tax bill and was collected by state taxing authorities. The “pick up tax” was not included in the new tax law. This means that states such as California, Florida and Texas would have once again collected a state estate tax in the form of the “pick up tax.” Keep in mind that there are some states that have a free standing estate tax that will continue to collect estate tax at the state level. California is not one of these states. However, for those who live in one of these states, additional tax planning is necessary.

The changes made by the American Taxpayer Relief Act may have a significant impact on your estate planning. If you already have an estate plan, you should consider having your estate plan reviewed to ensure that it still works the way it is intended to work given the law changes. If you do not have an estate plan, there is no better time than the present to get one in place. The good news is that these law changes offer more certainty than what we had in previous years in that there is no scheduled expiration date for the new law. If your estate plan is currently compliant, you may not need to worry about additional reviews for annually changing and expiring tax laws. Keep in mind that although there is no sunset date on the changes made by the American Taxpayer Relief Act, Congress is free to change it at any time just like any other law. So, although there is no absolute certainty, we are still free to enjoy more than we have had in the estate and gift field in a very long time. Here’s to a happy, healthy and well planned 2013!