The enactment of the Tax Relief Act of 2010 last December was big news for my clients who have acquired some wealth. The Act significantly, but temporarily, increases the federal estate, gift, and generation skipping tax thresholds. At least for the next 17 months (until December 2012) it presents my clients with the opportunity to pass on a substantial amount of their wealth tax free to their children and grandchildren.
For the last decade planning to limit federal estate taxes has been compared to buying a carton of eggs – you want to be sure to carefully note the expiration date. The Tax Reform Act continues the approach of setting an expiration date on the estate tax rules. Instead of a “buy by” date, it contains a “die by date.”
Here are the rules that apply for the next 17 months:
The estate tax threshold has been raised to $5 million dollars and the tax rate lowered to 35%. The maximum gift tax rate is also set at 35% (for total gifts that exceed a greatly increased lifetime exclusion amount of $5 million). The generation skipping tax (GST) exemption is also $5 million with a tax rate equal of 35%. This increase in the gift and GST tax exclusion amounts at least temporarily provides a wonderful opportunity to transfer significant amounts of wealth to future generations free of estate and gift taxes.
Unfortunately, the generous estate, gift and (GST) provisions of the Tax Relief Act of 2010 expire on December 31, 2012. If Congress and the President fail to agree, the tax regime will then return to the $1 million applicable exclusion amount and 55% maximum tax rate that existed in 2001.
The current debt ceiling rancor in the nation's capital may portend a particularly contentious debate over estate tax rules next year. When evaluating the “political risk” involved in delaying planning beyond the current two-year window, we need to acknowledge the possibility of an estate tax stalemate.
Simply letting the Bush tax cuts expire at the end of 2012 would increase government revenues by approximately $4 trillion dollars over the next decade and go a long way to resolving the deficit problem during that period. Stalemate might be an attractive "automatic" alternative to those who want to attack the deficit through both spending cuts and tax increases, which currently appears to be a majority of Americans.
A stalemate at the end of 2012 would boomerang us back to the 2001 tax thresholds of $1 million and rates up to 55 percent beginning on Jan. 1, 2013. Even a compromise could reduce the exemption to well below the current $5 million (portable to $10 million) amounts.
The potential for future political gridlock over estate taxes has some important planning implications. Planning based on transfers that will occur at some undetermined time in the future when the client dies bears a significant tax uncertainty risk.
We know what the rules are today but not what they will be in 18 months. Unfortunately, in creating wills and other planning for transfers that occur at your death, you need to plan for the estate tax law that will be in effect when you die not when you sign their will or trust or beneficiary designation. And we just cannot accurately predict what the estate and gift tax laws will look like in 2013 and beyond.
The bottom line conclusion:
For individuals and couples who have acquired some wealth that they want to protect and pass on to later generations, it is not safe to assume that exemption amounts will stay the same or increase in the future. There is relative tax certainty in the present but the future is filled with doubt and risk.
If you have acquired sufficient wealth to provide yourself with adequate personal financial security during your life, you might want to consider implementing immediately effective estate planning, such as through lifetime gifts, that will be more certain to limit taxes, provide for your family, and protect your wealth over the long term.