More certainty for estate tax planners and for taxpayers who want to arrange their financial affairs
The American Taxpayer Relief Act of 2012 (ATRA) has provided much needed certainty for estate tax planners and for taxpayers who want to arrange their financial affairs. For the first time in 10 years, beginning January 1, 2013, the maximum estate tax rate, the inflation-adjusted exclusion, and other estate tax features have been made permanent.
The top tax rate is 40 percent, the maximum exclusion for both estate and gift taxes is a unified amount of $5 million (indexed at $5.12 million for 2012 and $5.25 million for 2013), the tax basis of property acquired from a decedent is stepped up, and the portability of a deceased spouse's unused exclusion (DSUE) amount is preserved. The generation-skipping transfer (GST) tax exemption, which is tied to the estate tax rate, is also set at $5 million, adjusted for inflation. However, taxpayers should realize that inheritance taxes imposed by a state may apply to a lower amount, so some estate tax planning for state taxes may be appropriate.
If Congress had not acted on the sunsetting provisions, the maximum estate tax rate would have been 55 percent effective January 1, 2013, and the maximum exclusion would have been only $1 million. However, even though these changes are permanent and do not have an expiration date, one never knows whether Congress may change the law in the future.
Stepped-up basis is preserved for assets passing through the estate. This is particularly important for people whose estates are not large enough to owe estate taxes (under $5 million, as indexed for inflation). In 2010, when there was no estate tax, the Tax Code applied a modified carryover basis regime with $1.3 million worth of assets subject to a basis step-up (plus $3 million for property passing to the spouse). All other properties would have a carryover basis and thus could have significant built-in gains when acquired by the estate tax beneficiary.
Now, all properties passing through the estate for tax purposes are entitled to a step-up in basis, whether or not they are subject to estate tax. This will have a significant impact on income taxes for taxpayers receiving assets from the estate, insulating built-in gains from taxes, and allowing taxpayers to sell assets and invest them in other arrangements.
Unified estate and gift tax
Even though the lifetime exemption under the unified estate and gift tax ($5 million, adjusted for inflation) may never be used up, filing gift tax returns for annual gifts above the exclusion is still necessary. The annual gift tax exclusions ($13,000 for 2012; $14,000 for 2013) are much lower than the lifetime exclusion. However, thanks to the lifetime exclusion, taxpayers often will not owe any gift taxes on a gift, even one that exceeds the annual exclusion.
The portability of the DSUE amount was enacted in 2010 and originally applied where the first decedent in a married couple died in 2011 or 2012. In ATRA, Congress made portability permanent.
In the absence of portability, the first spouse to die could transfer property to the surviving spouse tax-free, by claiming the marital deduction. But the second spouse, as sole owner of the assets, was in danger of exceeding the applicable estate tax exclusion and owing more estate tax.
For example, a husband owns $7 million in property and the wife owns $5 million in property. Upon A's death, the husband's estate passes $2 million of property to his children, and $5 million in property to his wife, using the marital deduction. When the wife dies, she has $10 million in property (assuming that the wife's earnings and expenses offset each other), but only has an exclusion of $5 million. Thus, $5 million of assets are taxable.
Portability eliminates or substantially lessens this problem. If the husband passes $2 million to his children, and $5 million to his wife, he has a DSUE amount of $3 million. The wife, when she dies with an estate of $10 million, has an estate tax exclusion of $8 million ($3 million from the husband, plus her own $5 million exclusion), and will owe estate tax on $2 million, instead of $5 million. At a 40 percent maximum rate, this is a potential savings of $1.2 million to the wife (and to the husband and wife collectively). Portability lessens the need for complex estate planning when the husband and wife together have assets in the $10 million range (more or less).
Other tax provisions
ATRA provides additional certainty for other estate, gift, and generation-skipping transfer (GST) tax provisions. More liberal rules for using installment payments for estate taxes will continue to apply. The five percent surtax on estates and gifts between $10 million and $17,184,000, which is designed to offset the benefits of graduated rates, will no long apply.
Modifications to the exclusion for qualified conservation easements are permanently extended, again facilitating planning in this area. The repeal of certain distance requirements is permanently extended; accordingly, the exclusion is available to any qualified real property, located in the U.S. or a U.S. possession, that was owned during the three-year period ending on the date of the decedent's death.
ATRA also extended a number of GST tax provisions set to expire at the end of 2012. These included the GST deemed allocation and retroactive allocation provisions; clarification of valuation rules for determining the inclusion ratio; provisions allowing the qualified severance of a trust; and relief from late GST allocations and elections.
Finally, ATRA extended the IRA charitable deduction for two years, through 2013. Taxpayers age 70 ½ and older can make a maximum distribution of $100,000 directly from their IRA (traditional or Roth) to a charity, without including any of the distribution in income.
Not all of ATRA's provisions are beneficial to taxpayers. ATRA permanently extended the deduction for estate taxes imposed by a state, rather than a tax credit. The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) first repealed the state death tax credit for decedents dying after 2004 and replaced the credit with a deduction. ATRA also extended repeal of the deduction for qualified family-owned business interests, a provision that has been in effect since 2004.
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