“The only things certain in life are death and taxes” said Benjamin Franklin. His insight remains fully applicable three centuries later. Death taxes, levied by both state and federal governments, combine these two certainties into harsh reality. When your parent or other benefactor dies, you face both.
Death taxes
and their cousin gift taxes apply to transfers of property which are made for less than fair value and are not otherwise exempt
from taxation. The Federal Government has both a gift tax for donative transfers made
during lifetime, and an estate tax for donative transfers that occur after death. It
also imposes a “generation skipping tax” on transfers to grandchildren and
later descendants.
Pennsylvania has an inheritance tax that applies to
transfers after death and to those made within one year “in contemplation of
death.” Pennsylvania has no gift tax.
The recently
enacted Fiscal Cliff tax deal, the American Taxpayer Relief Act of 2012 (ATRA),
makes some changes to the federal estate and gift tax rules, but in the most
part gives “permanent” status to the rules that existed in 2012. Here is an overview of the current state of
the federal gift and estate tax rules.
Overview of
2013 Estate and Gift Tax Rules
40% Maximum
Rate. ATRA establishes a maximum tax rate of 40% for taxable gifts and estates.
This is an increase from the 35% maximum that existed in 2012.
Exclusion
Amount. A unified credit of $2,045,800 (for 2013) is available with respect to
taxable transfers by lifetime gift or at death. This credit effectively exempts a total
of $5.25 million* (for 2013) in cumulative lifetime and post-mortem taxable
transfers from the gift tax and the estate tax. This large “exclusion amount”
will continue to be adjusted each year for inflation. This means that, unless
the law is changed in the future, only a small minority of taxpayers should
ever be subject to federal estate or gift taxes.
Portability.
To the extent that the first spouse to die has not used up his or her exemption
at death, the unused exemption can generally be claimed by the surviving
spouse. ATRA makes this exemption “portability” a permanent feature of the estate
tax law. It provides the surviving spouse with the opportunity to have a larger
exclusion amount upon his or her death. See my article IRS publishesregulations on portability of estate and gift tax exclusion for more on
portability.
It’s important to note that an estate tax return must be filed at
the death of the first spouse in order to make the portability election.
Otherwise, the unused exemption amount will not pass to the surviving spouse.
Gift Taxes.
The rates for gift taxes remain unified with the estate tax rates. This means
that there is a 40% maximum rate on gifts in excess of the donor’s $5.25
million (in 2013) lifetime exemption.
In addition,
a donor can give up to $14,000 (in 2013) each year to any number of individuals
without gift tax consequences. This is
called the “annual exclusion” amount. Gifts made each year which are in excess
of the annual exclusion amount must be reported to the IRS. These “taxable”
gifts are deducted from the donor’s lifetime exemption. When the exemption is
used up, the donor (or estate) will owe gift or estate tax on the excess.
Example 1:
John has three children. He gives each child $14,000 in 2013 (a total of
$42,000). John does not have to report these gifts and has not used up any of
his gift and estate tax exclusion.
Example 2:
John gives his son $40,000 in 2013. He has made a “taxable” gift that must be
reported to the IRS. The gift uses up $26,000 of John’s gift and estate tax
exclusion.
Generation
Skipping Tax. The generation-skipping transfer (GST) tax is an additional tax
on the transfer of property from a grandparent to a grandchild (or later
generations). The tax is also assessed on property passed to unrelated
individuals more than 37.5 years younger that the person making the transfer.
ATRA makes
no changes to the GST tax. The exclusion amount is $5.25 million in 2013. Note
that the portability rules do not apply to GST transfers.
Step-up in
Basis for Inherited Assets. ATRA makes no changes in regard to rule governing
the step-up (or step-down) in basis for inherited property. This rule means
that the recipient's tax basis for inherited property is the property's fair
market value at the decedent's date of death rather than the decedent's cost
basis. As a result it can sometimes be more advantageous for a transferee to receive
appreciated property via inheritance rather than by lifetime gift. [With
lifetime gifts, the recipient’s tax basis is usually the same as it would have
been in the hands of the donor ("carryover" basis.)]
The step-up in basis
on inherited property can substantially reduce the income taxes due on the sale
of an asset by the recipient.
No Change to
Some Popular Estate Planning Techniques. ATRA did not address a number of
perceived estate planning “loopholes” which the Obama Administration had targeted for
closure. These strategies, such as limiting property valuation discounts and
the use of grantor trusts, continue to be available for the time being.
See my
article Obama Budget Proposes to Close Estate and Gift Tax Loopholes for more
about these controversial planning techniques.
Are These
Estate Tax Changes Permanent?
The years
from 2001 to 2012 were an age of great uncertainty for taxpayers and their
estate planning professionals. The estate and gift tax rules were temporary and
subject to “sunset.” As a result, building flexibility into wills and trusts in
order to deal with future changes in the law was a key aspect of estate
planning.
One of the
most important aspects of ATRA is its removal of the sunset – which means that
the 2013 rates and rules are made “permanent.” But taxpayers need to recognize
the contingent nature of that permanency. The new laws are permanent only until
Congress and the President agree to change them.
As the
political winds continue to blow towards deficit reduction, the estate and gift
tax laws may be soon revisited. Building flexibility into your estate plan
still makes sense. And taxpayers who want to take advantage of popular estate
planning strategies like valuation discounts and grantor trusts may wish to get their planning in place
soon.
Implications
of ATRA for Your Estate Plan
Here are my
thoughts on some of the implications of ATRA that might be important for your
estate plan.
Fewer People
are Subject to Federal Estate and Gift taxes. Under the law prior to ATRA the
estate and gift tax exemption was set to revert to $1 million dollars. As a
result, anyone who anticipated dying with an estate in excess of that amount
needed to build federal estate tax planning into their planning. Now, with an exclusion amount of over $5 million
dollars, indexed for inflation, it seems that many fewer people will have to
try to plan around these federal taxes.
This is a
Good Time to Review your Estate Plan. When the exclusion was set to revert to
$1 million per individual, many couples with estates of between $1 million and
$10 million included provisions in their estate planning documents that set up
so-called bypass (or credit shelter) trusts. These trusts were structured to use the exclusion amount of the
first spouse to die. With the exclusion now “permanent” at over $10 million,
and spousal portability, these couples may want to review their existing plans
to see if those trusts are still appropriate.
Those
couples who are certain that their combined estates will be under a total of
$10 million may decide to do away with the bypass trusts that are part of their current plans. However, couples should recognize that the benefits of their
bypass trust planning may go beyond tax savings.
These trusts
can offer many potential advantages including: the protection of assets for children
of a first marriage from loss due to a 2nd marriage of the surviving spouse (something I've seen happen many times);
protection from creditors; removal of asset appreciation from the taxable estate of
the surviving spouse; and professional management. Trusts (for example, disclaimer
bypass trusts**) can provide flexibility in the event of future reductions in
the exclusion amount or other changes in the law. And for those with estates
that may someday exceed $5 million, trusts can help ensure that a married
couple gets the full use of both of their estate tax exclusions. Portability
can be easily lost after the death of the first spouse due to the failure to
elect it or as a result of remarriage of the surviving spouse.
State Death
Taxes Remain Important. ATRA does not address state death taxes. In Pennsylvania
those inheritance taxes rates are 4.5% on children and up to 15% on others. In
some cases these state taxes can be deferred or even eliminated through
planning. Talk with your elder law and estate planning lawyer.
Portability
is not Automatic. For married couples,
the exclusion portability provisions of the law are not available to the
surviving spouse unless it is properly claimed. When your husband or wife dies,
you need to talk with a lawyer who is knowledgeable about this aspect of the law
to determine whether portability should be claimed. At present, a federal
estate tax return (Form 706) has to be filed to pass the deceased spouse’s
unused exemption to the survivor. This will involve some time and expense, and
you will need to consider whether filing the return makes sense for you.
Planning for
Larger Estates. Some individuals and
couples still have estates large enough to be subject to federal estate, gift,
and generation skipping taxes. With the current tax rate of 40%,
if you fit into this category your planning will be of critical importance to your heirs. Here are a couple
of planning ideas.
- Consider taking advantage of grantor trusts and other perceived “loopholes” now while they are still available.
- Lifetime gifts, using the annual exclusion or your lifetime exclusion or both, can produce large tax savings. Annual exclusion gifts can reduce your taxable estate by significant amounts especially if there are multiple recipients. Even gifts using your lifetime exclusion can remove future appreciation from your estate and can avoid state inheritance tax. Of course, you want to consider the potential loss of step-up in basis on gifted property. And always be careful not to give away what you may need during the rest of your life.
- For married couples bypass trusts still make sense for both tax and non-tax reasons.
- When your spouse dies, be sure that the executor or other personal representative of his or her estate takes the steps needed to elect portability of the unused estate and gift tax exclusion.
*Source:
Overview Of The Federal Tax System As In Effect For 2013, Joint Committee on
Taxation, January 8, 2013,
https://www.jct.gov/publications.html?func=startdown&id=4498.
**With a
disclaimer bypass trust you leave everything to your spouse outright, but give
her the right to disclaim all or part of the inheritance and have it go into a
bypass trust instead. Her decision can be based on the law and her
circumstances at that time.
2 comments:
We will be in the 28% 2013 tax brackets. I'm happy because we are skating close to the edge and the 2014 changes will keep us in the same tax bracket.
Post a Comment