On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012 (the “Act”), which made significant changes to federal estate, gift and generation-skipping transfer (“GST”) tax laws and also modified certain employee benefits related provisions of the Internal Revenue Code (“Code”).
What’s New? The Act increased the maximum estate, gift and GST tax rate from 35% to 40% for transfers in excess of the exemption amount.
What Stayed the Same? The federal transfer tax system remained “unified” – estate, gift and GST tax exemptions all remain subject to the same $5,000,000 exemption umbrella, as indexed for inflation. For 2013, the indexed exemption amount increases by $130,000 to $5,250,000 – up from $5,120,000 in 2012. (The gift tax annual exclusion also got a small bump – up from $13,000 per donee to $14,000.) And, unlike the prior two tax acts that increased the estate, gift and GST tax exemptions, the new law is not subject to a sunset provision that would automatically reduce these exemptions, so we can have more confidence in estate and gift planning into the future.
The Act also made “portability” a permanent feature of federal estate and gift tax law. A surviving spouse will remain able to utilize the deceased spouse’s unused estate and gift tax (but not GST tax) exemption remaining at death. However, to take advantage of portability, the deceased spouse’s executor must make an affirmative election on the deceased spouse’s federal estate tax return, which must then be filed with the IRS. In some cases, for a surviving spouse to get the benefit of the deceased spouse’s unused gift and estate tax exemptions, a federal estate tax return must be filed where the filing might otherwise be unnecessary (i.e., because the deceased spouse’s gross estate was less than the federal estate tax exemption amount, now $5,250,000).
What Does It Mean? Most importantly, the Act means that there is some permanency in the federal transfer tax after years of uncertainty. Given this new and much needed certainty, a number of steps might be considered:
- For a married couple whose Wills contain formula “credit shelter” bequests tied to the available federal estate tax exemption, significant state estate tax liability may be triggered at the death of the first spouse to die. For example, if the first spouse to die is a New Jersey or New York domiciliary, his or her estate may face a state estate tax liability in excess of $400,000. Many Wills may be revised with language that could minimize or eradicate that state-level tax at the first death, where appropriate. In addition to state estate tax considerations, many estate plans were designed to take advantage of both spouses’ estate tax exemptions when those exemptions were at much lower levels, and when trust planning was required, pre-portability, to get the benefit of the exemptions. Additionally, the initial plan that created the “credit shelter” formula bequest at the death of the first spouse when exemptions were in the $1 million range, may not be comfortable with $5,250,000 of family assets to be tied up in trust for the benefit of a spouse. Clients should consider whether a $5 million plus credit-shelter trust for a surviving spouse is necessary or appropriate when this decision is no longer dictated by estate tax savings.
- Many Wills contain formula dispositions for generation-skipping trusts that use the full amount of the available GST exemption. With that exemption now at $5,250,000 (and likely to increase in future years), those GST trusts may end up funded with far more than originally intended. For example, a testator whose Will was drafted as late as 2009 may have expected only a maximum of $1,000,000 to pass into his or her GST trust ($2 million using both spouses’ exemptions). In 2013, this same plan would likely cause $10,500,000 of a family’s inheritance to be held in lifetime GST exempt trusts. It may be time to take a fresh look at such formula provisions, and lifetime GST trust planning recognizing that each generation of married children will be able to pass in excess of $10 million free of federal estate tax to their children.
- The large (and now permanent) estate and gift tax exemption amount may allow you to simplify your overall estate plan. Testamentary trusts in Will planning should be revisited to determine whether the trust planning still makes sense where estate tax reasons are no longer driving the decisions regarding the creation and/or terms of the trusts. Further, irrevocable lifetime trusts (insurance trusts or otherwise) should be reviewed to make sure that they still accomplish their intended purposes. As noted above, lifetime trusts for descendents that were put in place for multigenerational transfer tax savings when estate exemptions were $1 million per person and $2 million per married couple, may not be needed or appropriate when the exemptions are $5.25 million per person or $10.5 million per couple.
- High net worth clients have unprecedented opportunities to transfer significant wealth to future generations, taking advantage of historically high gift and GST exemptions. By making early gifts and benefiting from the time value of money and other techniques that are presently available, substantial wealth can be moved down the generations outside of the federal and state transfer tax systems. Although the gift and estate exemptions are unified, and those who don’t use the exemptions during lifetime should be able to use them at death, lifetime planning offers the opportunity to multiply the amounts removed from gift, estate, and GST tax. High net worth clients shouldn’t miss the opportunity to benefit from early transfers and leveraged planning techniques.
- If you have fully utilized your available gift tax exemption in 2012, you may wish to make additional, non-taxable gifts to take advantage of the $130,000 increase in the 2013 gift and GST tax exemption.
If you have been considering some sophisticated leveraged sale planning (e.g., to “freeze” the value of an asset you think may see significant appreciation), the larger exemption amount can provide additional room to maneuver. Additionally, those considering transfers of minority, non-marketable interests in closely-held enterprises might expedite this review in case there are limitations placed on discounting these interests in future tax legislation that might arise as part of debt reduction negotiations.
With interest rates remaining at historic lows, you may wish to consider the continued viability of valuation discounting, including grantor retained annuity trusts (GRATs) and low interest AFR loans. Short term GRATs remain viable although it is possible that future tax law changes will eliminate this planning.
While the new law has provided a welcome certainty regarding transfer tax rates and exemption amounts, we can expect that there will be future debate on certain cut-backs of the benefits that we enjoy under current law. Earlier proposals that might resurface include making all grantor trusts includable in the gross estate of the grantor, requiring GRATs to run for a minimum number of years and/or to result in some minimum amount of taxable gift, and eliminating certain marketability discounts on inter-family gifts. Given this possibility, and as noted above, some planning steps may be better considered sooner rather than later.
