As you probably know, Congress avoided the so-called fiscal cliff by passing – at the 11th hour – the American Taxpayer Relief Act of 2012 (the 2012 Tax Act), signed into law by the President on January 2, 2013. The 2012 Tax Act makes several important revisions to the tax code that will affect estate planning for the foreseeable future. What follows is a brief description of some of these revisions – and their impact:
The federal gift, estate and generation-skipping transfer tax provisions were made permanent as of December 31, 2012. This is great news for all Americans; for more than ten years, we have been planning with uncertainty under legislation that contained built-in expiration dates. And while “permanent” in Washington only means that this is the law until Congress decides to change it, at least we now have more certainty with which to plan.
The federal gift and estate tax exemptions will remain at $5 million per person, adjusted annually for inflation. In 2012, the exemption (with the adjustment) was $5,120,000. The amount for 2017 is $5,490,000. This means that the opportunity to transfer large amounts during lifetime or at death remains. With the amount tied to inflation, you can expect to be able to transfer even more each year in the future.
The generation-skipping transfer (GST) tax exemption also remains at the same level as the gift and estate tax exemption ($5 million, adjusted for inflation). This tax, which is in addition to the federal estate tax, is imposed on amounts that are transferred (by gift or at your death) to grandchildren and others who are more than 37.5 years younger than you; in other words, transfers that “skip” a generation. Having this exemption be “permanent” allows you to take advantage of planning that will greatly benefit future generations.
Married couples can take advantage of these higher exemptions and, with proper planning, transfer up to $10+ million through lifetime gifting and at death.
The tax rate on estates larger than the exempt amounts increased from 35% to 40%.
The “portability” provision was also made permanent. This allows the unused exemption of the first spouse to die to transfer to the surviving spouse, without having to set up a trust specifically for this purpose. However, there are still many benefits to using trusts, especially for those who want to ensure that their estate tax exemption will be fully utilized by the surviving spouse.
Separate from the new tax law, the amount for annual tax-free gifts has increased from $13,000 to $14,000, meaning you can give up to $14,000 per beneficiary, per year free of federal gift, estate and GST tax – in addition to the $5 million gift and estate tax exemption. By making annual tax-free transfers while you are alive, you can transfer significant wealth to your children, grandchildren and other beneficiaries, thereby reducing your taxable estate and removing future appreciation on assets you transfer. And, you can significantly enhance this lifetime giving strategy by transferring interests in a limited liability company or similar entity because these assets have a reduced value for transfer tax purposes, allowing you to transfer more free of tax.
For most Americans, the 2012 Tax Act has removed the emphasis on estate tax planning and put it back on the real reasons we need to do estate planning: taking care of ourselves and our families in the way we want. This includes protecting you, your family, and your assets in the event of incapacity; ensuring your assets are distributed the way you want; protecting your legacy from irresponsible spending, a child’s creditors, and from being part of a child’s divorce proceedings; providing for a loved one with special needs without losing valuable government benefits; and helping protect assets from creditors and frivolous lawsuits.
For those with larger estates, ample opportunities remain to transfer large amounts tax free to future generations, but it is critical that professional planning begins as soon as possible. With Congress looking for more ways to increase revenue, many reliable estate planning strategies may soon be restricted or eliminated. Thus, it is best to put these strategies into place now so that they are more likely to be grandfathered from future law changes.
Income tax planning is now more important than ever.
If you have been sitting on the sidelines, waiting to see what Congress would do, the wait is over. Now that we have increased certainty with “permanent” laws, there is no excuse to postpone your planning any longer.