The debate over the winners and losers in the American Taxpayer Relief Act of 2012 (ATRA12) will go on for a long time. Probably well into the 2016 Presidential election. I have always been one to try to find the positives in every situation. ATRA12 leaves many issues unresolved but it did bring some permanence to what has been a “patch and postpone” tax policy.
The Federal Estate Tax is one important area of financial planning receiving a much needed level of permanence. No longer will your estate planning be significantly impacted by what year you die. The exclusion amount is permanent and will be indexed to inflation each year and the rate over the exclusion is fixed.
The new 40 percent rate is the only change from 2012 estate tax law. The rate is up from the 35 percent rate of 2010 through 2012, but less than the 45 percent rate of 2009 law that had been the President’s position. A change in the rate is the easiest change to deal with because it does not require the revision of familiar estate planning techniques.
State inheritance and estate taxes continue to be deductible in calculating the federal taxable estate. States that have their own estate tax coupled to the federal tax use the pre-2002 federal credit, with a top rate of 16 percent for taxable estates over $10.1 million.
The unified exemption will remain at $5 million and indexed for inflation since 2011. The 2013 exemption is $5.25 million for gifts made this year and the estates of decedents. The gift tax and the unified exemptions used to be different amounts but Congress has chosen to keep the two exemptions the same, as well as the GST exemption, which is also $5.25 million for 2013.
Had the 2012 estate tax laws been allowed to ‘sunset’, the estate tax exemption would have reverted back to their 2001 level of $1,000,000. The reality was that there is little historical precedent for Congress to actually decrease the estate tax exemption – such a shift hadn’t occurred since World War II. The President wanted an exemption of $3,500,000 and a tax rate of 45%. However, the federal estate tax is a very small source of revenue for government generating less than 1% of income in the most recent fiscal year. While anything is possible when it comes to Congress, no one seriously believed the exemption would be allowed to drop to $1,000,000.
Another important aspect of ATRA12 was the decision to make the portability rules for a deceased spouse’s unused estate tax exemption amount permanent. This new law may significantly reduce the use of bypass trusts for all but the wealthiest of families. Portability was first introduced in the Tax Relief Act of 2010 as a provision allowing the unused portion of a deceased spouse’s estate and gift tax exemption to be transferred to the surviving spouse. This new “portability” of the unused exemption meant a couple could exclude the first $10,000,000 of their estate without the need for a bypass trust. In order to claim portability, estates must file a timely estate tax return (even if not otherwise obligated to do so) in order to make a portability election and report the amount of the unused exemption that remains from the decedent as a carryover to the surviving spouse.
Several tax provisions concerning the generation skipping tax (GST), including the rules for deemed allocation of GST exemption, the GST inclusion ratio, conservation easements, and qualified severance are also made permanent.
ATRA12 did not curtail a taxpayer’s ability to take advantage of the estate planning techniques working so well in this low interest environment. The President had suggested new rules requiring a minimum term for Grantor Retained Annuity Trusts (GRATs), revising the grantor trust rules which allow grantors to make additional tax-free gifts to the trust by paying the trust’s income tax, and eliminating valuation discounts for transfers between related parties. None of these proposals were included in ATRA12.
The new tax rates affecting wealthier taxpayers will be the bigger issue when contemplating certain estate planning strategies. Grantor trusts may be counterproductive for some families because the grantor pays the tax at the new tax rates. It will be important to review these trusts especially if the beneficiaries are in a lower tax bracket. It may make sense to terminate these trusts and make distributions to beneficiaries. Such planning would take advantage of the beneficiaries’ lower brackets, but the purpose of the trust should be reviewed.
The step-up in cost basis for appreciated assets has been retained in ATRA12. The effect of the increase in capital gains tax should be considered when deciding to make gifts of appreciated assets. There is a step-up in basis for assets gifted during lifetime. Assets transferred by gift retain the donor’s basis except if the asset value on the date of gift is less than the donor’s cost. A little known rule gives the beneficiary a split basis, which prevents the donor from realizing the loss on the sale of the asset.
“Permanence” is welcome but this only means the new provisions will not automatically sunset and revert to a less favorable law. The new provisions are in effect until Congress decides to change it. It would be naïve to assume that Congress is done making changes to the tax law, even to the estate tax with budget deficits still in the trillions.
- The estate tax rules were part of the permanent provisions in ATRA12.
- Permanent portability rules will reduce (or eliminate) the need for bypass trusts in estate planning.
- Many sophisticated estate planning techniques are still valid but the impact of income taxes will need to be evaluated.