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Permanent Estate Tax Relief

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One of the major elements to ATRA 2012 is the fact that it has finally given the estate and gift tax a permanent law upon which taxpayers can rely.  By way of background, the estate tax has been in a state of constant uncertainty since the 2001 tax law that sought to “repeal” the estate tax. Unfortunately, the 2001 law called for the repeal of the estate tax for 2010 decedents (coupled with complicated income tax rules called ‘modified carryover basis’) but that law was set to expire in 2011.  In 2010, the 2010 tax law relaxed the applicability of the estate tax but that law was, again, set to expire in 2013.  Now the 2012 ATRA provides that the estate tax will only apply to estates where the value of the estate is greater than $5,000,000. Better yet, the $5,000,000 threshold is indexed for inflation from 2011 so that the federal estate tax will only apply to estates with a value (in 2013) greater than $5,250,000.

A second aspect to the revision was on the estate tax rates. The ATRA 2012 now sets the estate tax rate at 40%. Historically, before 2001, the estate tax had included a graduated rate structure leading up to a 55% bracket. The 2001 law gradually reduced the rate to 45% and, the 2010 law (that reset the exemption at $5,000,000) also dropped the rate from 45% to 35%. The new law seems to set a compromise that allows the tax to be imposed at a 40% rate, but again, it will only apply if the value of the estate exceeds the exemption of $5,250,000.

Under the federal estate tax, the rules have always been applied to allow tax free transfers to a spouse (as long as the spouse is a US citizen) or to charity (as long as the charity is qualified, generally called an IRC 501(c)(3) charity). The tax has only applied to transfers to other beneficiaries and only if the value of the estate exceeded the sum, now known as the ‘Basic Exclusion Amount’ (formerly the applicable exemption or unified credit amount) which is the $5,250,000, indexed for inflation.   As a result of these changes, many clients will no longer be subject to the federal estate tax and will no longer need federal estate tax planning. Unfortunately, as with any ‘permanent’ law, it is really only ‘permanent’ until Congress meets again.  However, while it seems relatively likely that the estate tax exemption will remain at $5,000,000 or above for a foreseeable time, it is hard to speculate what the law will be in the year 2025 or 2035.   Unlike income tax planning, where a tax year ends each calendar year, the estate tax applies at the time of a taxpayers passing. As such, planning can become more complex as most people do not know when they will pass or what the size of their estate will be at that time.

Two additional outgrowths of the 2010 Tax law were also made permanent in 2012, the rules for gifting and the new rules for “portability” of estate tax exemptions. The estate tax is really a ‘wealth transfer tax’ in that it looks at cumulative transfers of wealth over time, culminating when an individual passes. Each year a taxpayer can gift an “annual exclusion” amount (now, for 2013, $14,000) to as many donees as they would like without impact on this wealth transfer tax regime (the estate and gift tax). Gifts in excess of this annual exclusion are “taxable” gifts in that they count to use up a portion of the persons exemption amount, the ‘Basic Exclusion Amount’.  Before 2010, donors could gift taxable gifts up to $1,000,000 before gift tax would be due. The 2010 tax act unified the amount that could be gifted during life and at death at the $5,000,000 (indexed) threshold. Under ATRA 2012, this gifting ability has been permanently unified. Thus. before paying gift tax, an individuals’ “taxable gifts” must exceed the BEA threshold (currently $5,250,000) and that is after the $14,000 annual exclusion gifts. Thus the ability to gift large transfers of assets seems to be relaxed for the foreseeable future. This gift tax exemption will be useful for families seeking to transfer a family business or farm or valuable vacation home without gift tax. Before a large transfer of wealth, care should be taken because of the way that the income tax is coordinated with the estate tax.

A second aspect of the 2012 ATRA is called “portability” of estate tax exemptions. In the past, a spouse could leave assets to a surviving spouse without tax; however, that transfer would waste (not utilize) the estate tax exemption of that predeceasing spouse. Thus, many planners would suggest that families leave assets to a trust (generically referred to as a ‘credit shelter’, ‘bypass’ or ‘family’ trust)  for the surviving spouse to ensure that the exemptions of both spouses/parents are used and that twice the amount of the exemption can be shielded from estate tax. However, now that the estate tax exemption is “portable” this planning may not be needed. Family should still consult with counsel on whether a trust or portability is better for their plan as additional restrictions apply.

Finally, remember that there are still STATE estate tax implications. Many states, like New Jersey, impose a separate estate tax. In New Jersey, spouses can leave assets tax free to their spouse or tax free to charity but a tax will be imposed to the extent that the value of the estate exceeds $675,000. The NJ tax rates are not as high as the federal rate, but can range from 5% to 16% (over $10 million). In addition to the estate tax, NJ also imposes an inheritance tax, but that tax does generally not apply to transfers to a spouse child or grandchild.

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