Congress passed the American Taxpayer Relief Act of 2012’’ (“ATRA”) that made the federal estate tax exemption permanent on January 1, 2013. In a last minute move before we went over the “fiscal cliff”, in an 11th hour tax law passed by the Senate on New Year’s Eve, and by the House of Representatives one day later, mostly what Congress did was to make permanent the system that has been in effect for the past two years. I am just thankful that we now have permanence that has been missing for the last 12 years.
What’s most important to us as planners is how the “fiscal cliff” deal changes will affect our clients’ existing estate plans and whether any changes are necessary.
Most estate planning documents deal with non-tax issues, including the very valuable benefit of structuring assets to avoid the probate process at death and to provide creditor protection for beneficiaries. The Power of Attorney, Conservator, and healthcare documents are all extremely important and necessary. These documents are critical to avoid unnecessary court oversight and expense, delay, and intrusion.
What are the provisions of the ATRA that will affect my estate planning practice or clients?
Top gift, estate and GST tax rates are set at 40%. ATRA 2012 establishes the top gift, estate, and GST tax rates at 40% for gifts made and decedents dying in 2013 and thereafter. This top rate is higher than the 2012 rate of 35%, but lower than the 55% rate that would have come into effect on January 1 in the absence of legislation. This top rate will apply to transfers exceeding the exemption amounts.
Exemption amount: Permanently set at $5,000,000 per client, indexed for an inflation adjustment beginning 2012 ($5.12 million in 2012). The estate tax exclusion amount for deaths in 2013 will be $5.25 million.
Gift Tax Rate: The estate and gift taxes will remain unified, so the $5 million exemption also applies for gift tax purposes, and will follow the estate tax rate. The rate was permanently set to 40% of the amount over the exemption. In addition, the annual gift exclusion amount was raised to $14,000 per person this year.
Generation Skipping Tax Rate: The generation skipping tax exemption follows the estate tax rate. The rate was permanently set to 40% of the amount over the exemption.
Portability made permanent: Further, the deal continues the estate tax portability provisions that allow a surviving spouse to take advantage of his or her deceased spouse’s unused exemption amount. This provision allows a surviving spouse to avoid complicated estate planning by recognizing that gifts between spouses are typically tax free and allowing the exemption to be portable between both spouses. In order to utilize this, a 706 tax return MUST be filed within 9 months, so in my opinion, portability is less than optimal in many cases.
Use of the A/B/Bypass Trust: Some of the discussion since passing this legislation has focused on the use of A/B trust structure, and whether planning is better without the credit shelter trust. I still am in favor of estate planning with an A/B/C trust, especially to preserve a decedent’s share in case of a remarriage of the survivor spouse, and also to allow the flexibility of state estate tax planning. As long as the trust is flexible enough to allow the options of funding the various sub-trusts to the survivor spouse, which ours does, you still have the benefit of planning that gives the most flexibility to the survivor. We will review the provisions in our trust as a precaution
Upside to IRA Planning in ATRA
Hidden in the law — along with the typical year-end riders attached to a last minute piece of legislation, including tax breaks for NASCAR and the alternative fuel industry — were a couple of tangible impacts to the retirement world, though one may offer just short-term benefits. First, it looks as though folks hoping to roll over their regular 401(k)s to Roth 401(k)s may get an opportunity for a long-term tax break — lord knows you’re going to need one, as your taxes really are going to go up. A new provision in the package will allow 401(k), 403(b) and 457(b) participants to make the leap to a Roth 401(k) without waiting for the traditional qualifying events (retirement, reaching age 59 1/2 or changing jobs). Why? Because doing so immediately sends that tax deferral — which you’ll have to pay up front — to Washington, rather than waiting until your far-off retirement day, and Washington wants your taxes. It’s a huge opportunity for regular folks to make that Roth conversion – provided they have the financial wherewithal to pay those taxes much sooner than later.
Potential future legislation. It is important to note that there may be a push for additional revenue-raising legislation as political debates continue. The current administration has expressed its desire to limit the advantages of GRATs, grantor trusts, GST-exempt dynasty trusts, and transfers in family entities that qualify for valuation discounts. Clients who might consider employing those techniques may wish to do so sooner rather than later.