DBTC Law Firm

Huge (!) development in estate and gift tax law.

On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012.  Generally, it “kicked the can down the road” for a few months on the pending “fiscal cliff,” but it permanently enacted one of the most significant changes in estate and gift tax law in the last several decades.  Now couples, with proper estate planning, can leave up to $10.5 million  in estate value to their chosen beneficiaries without paying any federal estate taxes.  This resolved a vast amount of uncertainty and difficulty which has existed in the estate planning area for the last several years.

No one is eager that the estate which they wish to leave to their children, descendants and other beneficiaries be reduced by death taxes.  Arkansas, for several years, has not had any kind of death, inheritance or estate tax.  However, the Federal Government has imposed a tax on the value transferred through decedents’ estates since 1916.  Both the amount of estate which was protected by deductions, exemptions or credits, and the rate of tax on the unprotected estate have varied greatly since 1916.   In 1980, the first $161,000 of estate was protected, with the maximum rate being 70%; by 1990, the first $600,000 of estate value was protected, with the maximum tax rate being 55%; that regimen continued substantially intact until 2002, when the exemption increased fairly rapidly from $1 million with maximum rates at 50% in 2002, to a protected amount of $3.5 million and a maximum rate of 45% in 2009.  Then the roller coaster really began: estate taxes were completely rescinded in 2010, as a result of legislation passed in 2000; however, they were scheduled to be reimplemented on January 1, 2011, protected only to the extent of $1 million and a 55% tax rate.  In the last few days of December 2010, Congress passed a temporary action which increased the protected amount to $5 million and reduced the maximum tax rate to 35% but by its terms, it also “sunsetted,” reverting the estate tax effective January 1, 2013, to provide only $1 million of protection and a 55% maximum tax bracket.

Long-term strategic planning for moderately wealthy and wealthy Americans was rendered practically impossible by these substantial uncertainties in the tax law over recent years.  It was thus with huge relief for both estate planners (lawyers, accountants, investment advisors, insurance agents and trust officers, to mention the primary professions) and taxpayers when President Obama signed the American Taxpayer Relief Act of 2012 into law.

This Act accomplished these very significant benefits for all Americans:

  1. Its provisions are permanent; even though they can be revised at any time by appropriate legislative action, they do not have any built-in “sunset” dates–which were so problematic in the 2001 and 2010 legislation–which would trigger reversion to much lower levels of protection and much higher tax rates.  It will require significant impetus for Congress to make yet another strategic revision in this tax code.
  2. The amount of protection that is provided is $5.25 million per person ($10.5 million per couple) which is indexed to increase with inflation.  This is a significantly higher level of protection than has ever existed in the tax laws before.
  3. The tax rate is permanently set at 40%, a lower maximum rate than has existed in decades.
  4. Making permanent the recent and temporary provision of “portability”– to the extent one spouse does not effectively use their exemption protection of $5 million, the unused portion is carried forward and may be used by their surviving spouse at their subsequent death.  However, use of portability requires that an estate tax return be timely filed on the first death, even though there are no taxes due and the return would not otherwise be required.
  5. The gift tax was developed to “protect” the estate tax.  Someone who otherwise had a taxable estate might conceivably avoid estate tax by making substantial gifts during their life, even on their deathbed, to avoid their estate being taxed at their death.  Thus, since 1976, gifts are subject to the same rate of taxes as estates are to protect the estate tax from being evaded by lifetime gifts.  Though protection for gifts is available through the estate tax credit, use of that credit during life reduces the amount of credit remaining at death.  Since 2001, while the estate tax protection increased substantially from $1 million to $3.5 million,  the gift tax protection did not increase correspondingly, so that families wanting to make large gifts to children or descendants before their deaths either had to pay gift taxes, or hold the assets until their death to take advantage of a higher estate tax credit, making planning complex and uncertain.  The gift tax credit has now been “unified” again with the estate tax credit, so that each person has $5.25 million of credit which they can apply to lifetime gifts, or estate value at death,  as may best serve their interests.

Though the above by no means recites all of the facets of the American Taxpayer Relief Act of 2012, it demonstrates that a great amount of certainty and predictability has been brought back into the estate planning process, while substantially increasing the amount of estate that is protected and decreasing the maximum rate of tax.

Many people have been compelled to accomplish formal estate planning through their attorney in order to avoid the specter of estate taxes.  Under these new rules, only the very wealthy run any risk of estate taxation.  Some predict that this will reduce substantially the amount of estate planning that is requested and accomplished.  Those who think their wealth is not sufficient to accomplish estate planning do not understand the importance of many facets of such planning which have nothing to do with the amount of wealth.  These concerns include these very important features which have no relationship to the amount or complexity of your wealth:

  1. Designating the guardians who would care for your minor children if you were deceased;
  2. Designating those persons who would take care of you and your affairs if you were incapacitated;
  3. Setting up trusts to protect children and descendants who may be of legal age to inherit (18 or over), but still youthful in their prudence, would have their inheritance subject to the administration in control of trustees until they reached their later age of vesting;
  4. Arranging for the disposition of particular items of sentimental or personal value;
  5. Providing means to protect wealth that your children will inherit from their creditors;
  6. Clarifying who will receive what portions of your estate, which can be especially important if there are blended families with stepchildren, family members with disabilities or disparities between the needs of particular beneficiaries or your desire to differentiate between what different beneficiaries may receive;
  7. Avoiding the cost and delays of probate procedures; and
  8. Protecting estate assets from the claims of creditors.

These concerns, even in a modest estate, require the attention of experienced and competent estate planning professionals.

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