On January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012, which was intended to avert the so-called “fiscal cliff” and end much of the economic uncertainty for taxpayers. This article will summarize this important legislation and discuss how these provisions may impact you in the future.
The Top Tax Rates Have Been Modified.
Starting in 2013, individuals in the top income tax brackets (those with taxable income in excess of $400,000 for single filers or $450,000 for married filers) will be subject to higher income tax rates. The top individual income tax rate for 2013 increases from 35% to 39.6%, and the top capital gains and dividends tax rates increase from 15% to 20%. Additionally, a .9% Medicare surcharge on individual income tax and a 3.8% Medicare surcharge on investment income go into effect in 2013. These surtaxes, created by the recent healthcare legislation, apply to single filers with income exceeding $200,000 and married filers with income exceeding $250,000. With these new rates, taxpayers in the top income tax brackets may now be taxed at rates that are more than 8% higher than in 2012.
In light of these changes, a taxpayer who made previous gifts to a grantor trust and who is now affected by these higher rates may decide to terminate the trust’s “grantor status” and shift the income taxation to the trust and its beneficiaries. Such planning may not only lower the taxable income of the grantor, but it may also capitalize on the beneficiaries’ lower tax brackets.
The Estate and Gift Tax Rules Have Been Made “Permanent.”
The new law provides that the estate, gift, and generation-skipping transfer (“GST”) tax exemptions will continue at the $5 million level, indexed annually for inflation. The exemption amount for 2013 is $5.25 million. The new law also makes permanent the ability to pass to your spouse your unused estate and gift (but not GST) tax exemption at your death (a concept known as portability) by filing a timely Federal Estate Tax Return (Form 706). This means that for a married couple who has not made any previous gifts, the surviving spouse could have up to $10.5 million of estate and gift tax exemption to apply to future gifts or to his or her estate. This is important considering the new law also increases the tax rate on estates and gifts to 40%, an increase of 5% from the 2012 rates.
How Does This Affect You?
Now that the economic uncertainty has diminished, many are asking how this new legislation will impact their estate planning. For those that have delayed creating an estate plan due to the past uncertainty in the tax laws, this is the first time in over a decade that we have had “permanent” legislation in the realm of estate and gift tax. Thus, now is a good time to move forward with any delayed planning and to review your existing estate plan.
For example, with portability becoming permanent, the new law means you should specifically review any plan that automatically funds a residuary trust at the death of the first spouse. In fact, under the new law, having this type of estate plan may now result in unintended effects (such as disinheriting a spouse, children, or otherwise). Additionally, with higher income tax rates coming into effect in 2013, Federal income tax planning is now more important than ever in drafting your estate planning documents. You should also review any plan that has GST tax planning to ensure the plan still creates your intended outcome.
For those who completed gifts by the end of 2012, the planning may not have been in vain. Though Congress has deemed the new legislation pertaining to the estate and gift tax laws “permanent,” this only means the “sunset” provisions that were enacted under the old law have been removed. Thus, while the $5 million estate and gift tax exemption is likely to remain in place for the foreseeable future, discussions in Congress are ongoing, and additional changes to the transfer tax laws are likely. For example, future tax laws may limit the use of some of the advanced estate planning tools used in 2012 (such as GRATs (Grantor Retained Annuity Trusts), QPRTs (Qualified Personal Residence Trusts), and FLPs (Family Limited Partnerships)). Since some or all of these vehicles may not be available in future years, if they are otherwise appropriate for your estate plan, they should be included in your considerations.
For those who thought they missed their opportunity to take advantage of the increased exemption in 2012, this new law provides a second chance and a reason to consider gifting in 2013. Even with the 5% increase in the estate and gift tax rates, lifetime gifts are generally a better way to transfer wealth than testamentary devises. To start, lifetime gifting allows you to take advantage of the advanced estate planning tools named above, thus reducing the amount of the taxable gift and leveraging the exemption by removing any appreciation and income of the gifted property from your taxable estate. Second, some forms of lifetime gifts take advantage of the annual gift tax exemption. Beginning in 2013, you can generally give up to $14,000 a year during your life to any number of people without using any portion of your lifetime exemption. Finally, lifetime gifts take advantage of the “tax exclusive” nature of the gift tax. Unlike a testamentary devise where the funds used to pay the estate tax are taxed beforehand in the decedent’s gross estate, the funds used to pay taxes due on a lifetime gift are, in most cases, removed from the gross estate and thus are not included in the calculation of the tax liability.
In summary, the answer to the question of how this law will affect you mostly lies in the provisions of your current estate plan. It is highly recommended you take the time to review your documents with your estate planning attorney.
For more information regarding this article, please contact Liz Diaz at (941) 329-6631 or firstname.lastname@example.org.