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Whatever Happened to the Estate Tax?

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Posted on Jan 09, 2013 | Share this post: Like Us on Facebook Join Us on Google Follow Us on Twitter

On New Year’s Day, Congress passed “permanent” changes to the estate tax laws, something that had not been done in 12 years.  During those years, the estate tax exemption increased from $675,000 to $3.5 million (2009), was repealed for one year (2010), and finally rose to $5.12 million in 2012.  Twice during that period we were within a few weeks of the exemption automatically dropping back to $1 million.  A strange time, to say the least.  Now, with the American Taxpayer Relief Act of 2012 (the formal name of the New Year’s Day bill, also known as ATRA), passed at the last minute, we finally have some changes that do not automatically expire.

So what are the changes?  Perhaps taking the easiest route possible, Congress essentially made the estate tax law enacted at the end of 2010 permanent.  The 2010 law started with a $5 million exemption in 2011, and that amount was indexed for inflation in later years, which is how we ended up with $5.12 million as the exemption in 2012.  For 2013, the exemption will reportedly be $5.25 million.  In future years, the exemption will continue to rise with inflation.

The main change from the 2010 law is that the top estate tax rate will be raised from 35% to 40%.  This is still less than the estate tax has been historically; the top marginal estate tax rate has been as high as 55% (and even 60% when certain adjustments were applied).  The increase in the marginal rate will probably make the most difference in the amount of estate tax actually paid, but it has less of an impact on planning.

ATRA retains the other elements of the 2010 law, including the fact that the full $5.25 million may be used for lifetime gifts.  In addition, the annual gift tax exclusion had been $13,000 since 2009, but that figure has been indexed for inflation and is $14,000 for 2013.  This means an individual can give away up to $14,000 to any recipient in 2013 without a gift tax return being required and without using up any of his or her combined $5.25 million gift and estate tax exemption.  If the gift is larger than $14,000, the gift will use up part of the individual’s $5.25 million lifetime exemption.  Any portion of the $5.25 million that is not used during lifetime remains available as an estate tax exemption at death.  Before 2010, the lifetime gift exemption had never exceeded $1 million, even when the estate tax limit was higher.  So individuals will continue to have the flexibility to give away significant assets while alive, which can be used to leverage the total exemption to further reduce estate taxes.

Another element of the 2010 law that has been made permanent is “portability,” which is the ability of a surviving spouse to use a deceased spouse’s unused estate tax exemption.  Think of it as credits the government gives the surviving spouse that he or she is allowed to hold onto and apply against his or her own estate.  The surviving spouse, however, must file an estate tax return because portability must be elected on the return to be used later.  The law attempts to give married couples who don’t set up an “A-B” Trust the ability to use both exemptions, so that a married couple may leave roughly $10 million without estate tax.  As discussed below, portability is not as good from a planning perspective as the traditional A-B Trust arrangement, but it is a helpful cleanup strategy when the first spouse dies, after which it is too late to set up that type of plan.

Of course “permanent” does not mean the estate and gift tax law will never change, only that it will not automatically change.  There are no “sunset” provisions that require lawmakers to revisit this area.  Those in Congress seeking more tax revenue may want to lower the limits and those opposed to “death taxes” in general could still argue for a complete repeal, it’s hard to imagine a huge impetus from either side to push for more changes any time soon.  Most people are not as familiar with the estate tax as they are with the income tax, the estate tax raises a relatively small amount of revenue compared to other taxes, and it impacts a very small group of Americans.  Congress may be content to let this issue lie for quite some time.