Out With the New and in With the Newer
By Jeff Moore
Like most of you, I too, put all of my New Year’s celebrations on hold until I finally heard that Congress passed the 2012 American Taxpayer Relief Act (“ATRA”) on January 1, 2013, and saved the nation from the “fiscal cliff.” While many would argue that ATRA (we’ll call it the “2012 Tax Act”) fell well short of solving all our fiscal problems, there was at least a sigh of relief from this estate planner’s perspective.
First, we now have some certainty in the estate and gift tax laws. The 2012 Tax Act is a new and permanent law that replaces the “new” 2010 Tax Act. Granted, nothing is permanent when Congress is in session, but at least at this point there are no looming repeals, no sun-setting provisions, no “clawback”, and no more guessing games. Since 2001, there has been a great deal of uncertainty as to the estate and gift tax exemptions. Recall that the “2001 Tax Act” raised the estate tax exemption from $600,000 to $675,000 with a phasing increase to $3.5 million, and then ultimately a complete repeal of the estate tax in the year 2010. The gift tax was to remain in existence. But because the repeal itself was deemed to create a deficit in 2011, the law required that the repeal itself had to be repealed effective 2011.
The law was a limbo game for nearly a decade. During that time, nobody really believed that the estate tax would actually be repealed . . . well, at least not until it actually was in 2010, albeit for only one year. So Congress then passed the “new” but temporary “2010 Tax Act”, which fixed the exemption for 2011 at $5 million, $5.12 million for 2012 (with the top estate tax rates at 35%), but then BACK to $1 million come 2013 if Congress did nothing else. In addition, the top estate tax rate would raise from 35% to 55%. The limbo guessing game as to what the law would be and when was in full swing.
The passage of the 2012 Tax Act, with its permanent provisions, put an end to the guessing game. It permanently replaces the “new” 2010 Tax Act. Here’s a look at some of the key elements of the “newer” law:
Federal Estate Tax Exemption Amount. The new estate tax exemption amount is $5.25 million. In addition, this amount is indexed for inflation so it will presumably rise over future years. This $5.25 million is a significant increase from the potential setback of the potential $1 million exemption amount that would have taken effect without the passage of the new 2012 Tax Act. An estate exceeding this $5.25 exemption amount is subject to the federal estate tax.
Federal Estate Tax Rate. The top estate tax rate on the amount in excess of the federal exemption amount is now 40%. As a practical matter, it is a flat 40%. This is a 5% increase over the 35% flat rate under the 2010 Tax Act, but it is better than the marginal 40% to 55% rate that we were heading towards without the passage of the 2012 Tax Act.
Federal Lifetime Gift Exemption. The federal lifetime gift exemption amount is the same amount as the federal estate tax exemption amount, or as the federal estate tax exemption amount, or $5.25 million. In other words, any aggregate gifts during life that do not exceed the amount of $5.25 million will not trigger any payable gift taxes. Once the lifetime gift exemption is used, however, a gift tax (i.e., 40% of the gifted amount) would be due. In addition, the amount of the gift exemption used during life effectively reduces the donor’s estate tax exemption amount available at the time of their death.
Annual Exclusion. The annual exclusion is the gift amount that each person can transfer to an unlimited number of individuals free of gift tax and without using any portion of their lifetime gift exemption. The annual exclusion was $13,000 last year, but it is set at $14,000 for 2013. The annual exclusion is also indexed for inflation—but only in $1,000 increments. Thus, the annual exclusion amount will presumably increase in future years but not until the inflation adjustment brings the annual exclusion to $15,000.
Federal Generation Skipping Transfer Tax. The generation skipping transfer (“GST”) tax exemption amount is also set at $5.25 million. A generation skipping transfer is any transfer to a person that is deemed two or more generations below the transferor (i.e., a grandchild or great grandchild, etc.). Any such “generation skipping” transfer that exceeds the $5.25 million aggregate GST exemption amount is subject to a 40% tax in addition to the 40% gift or estate tax. We know you love those grandkids, but be careful of this potential double tax and plan appropriately.
Federal Portability. The 2012 Tax Act also made the unique “exemption portability” idea a permanent part of the estate planning tool chest. If a spouse dies without using all of their federal estate tax exemption, then the surviving spouse can apply the deceased spouse’s unused federal exemption amount at their own death—and in addition to their own estate exemption amount. This is called “portability”. However, the surviving spouse must make an affirmative election to claim this portability of the decedent spouse’s unused exemption. The election is made by simply filing a federal estate tax return on behalf of the decedent spouse—even if no such return would have been required for such spouse (i.e., the decedent spouse’s estate was under the $5.25 million filing threshold). But there are several reasons why married couples should still do tax planning wills or living trusts to lock in the use of each spouse’s exclusion at the first death. One reason is that portability does not apply for Oregon death tax purposes. This means that if the estate plan doesn’t have a bypass type trust to use the decedent spouse’s $1 million Oregon estate tax exemption, the surviving spouse can only use their own $1 million Oregon exemption and the decedent spouse’s Oregon exemption is lost. In addition, portability only applies for the “last-to-die spouse”. For example, say a surviving spouse had a $3 million portability amount from his or her first deceased spouse. The survivor remarried and that spouse also subsequently passed away with only a $250,000 portability amount. The surviving spouse’s portability amount changes from $3.5 million to $250,000. In summary, portability is a helpful bonus but not a tool to replace appropriate estate tax planning.
Oregon Estate Tax. The Oregon estate tax exemption is not affected by the 2012 Tax Act. The 2012 Tax Act is a federal law. Thus, the Oregon exemption remains at $1 million. The Oregon estate tax rate for assets exceeding $1 million is a marginal rate of 10% to 16%. Oregon does not have a gift tax or a generation skipping transfer tax, and it does not have portability. That said, it is important to note that making gifts is often a helpful strategy to reduce the Oregon estate tax because such gifts do not reduce the $1 million Oregon estate tax exemption. However, because assets receive an adjusted basis to the date-of-death value upon a decedent’s death, some thoughtful analysis should be taken as to which assets to gift during life. It is more tax advantageous to gift cash or high-basis assets because the donor’s cost basis of the gift carries over as the donee’s basis and the donee may have capital gains tax on the resale of the gifted assets.
So, while the 2012 Tax Act may not be a fix to all our fiscal concerns, at least now we have some permanent laws that provide known parameters for appropriate estate tax planning.