Estate and Gift Tax Update
The American Taxpayer Relief Act of 2012
A wonderful client of mine recently shared a joke with me. I thought the joke so humorous, and later, so applicable to many situations in life, that I feel it bears telling again – here it is. Two men (acquaintances) unexpectedly see each other at a shopping mall. One of the men is fifty (50) years of age, the other eighty (80). The younger man enthusiastically says to the older man, “how’s it going, how are you doing, how are you getting along?” The older man, without hesitation, replies, “Well, I’ll tell you how it’s going, and in the meantime, I’ll describe to you what it’s like to be 80 years old – I had a dream recently. In my dream, I dreamt that I was falling from the top of a 20-story building, and on my way down, as I passed the fourth floor of the building, I saw an open window – and inside that window, a woman sitting at an office desk. The woman happened to be looking out the window, and seeing me come by, smiled, and called out to me, ‘how’s it going out there?,’ to which I replied, ‘Everything’s going well so far.’ ”
This bit of humor may aptly describe how many clients felt about the estate and gift tax laws during the last quarter of 2012. However, despite the uncertainties that existed in 2011 and 2012, the overall situation as of January 1, 2013 remains very favorable. In the following paragraphs, I will provide a brief summary of the federal estate tax laws leading up to the 2012 Act and a summary description of the new laws relating to the estate and gift tax. In this article, I will focus on the specifics of the 2012 Act as they relate to the estate and gift tax and not the full scope of the 2012 Act.
In 2001 we had EGTRRA, the 2001 Economic Growth and Tax Relief Act. Under EGTRRA, the federal estate tax was to be repealed in 2010 after a long phase out period. After the phase-out, the federal estate tax exemption was scheduled to be $1 million with a maximum graduated tax rate of 55%. Then we had the 2010 Tax Relief Act that re-established the federal estate tax as of the beginning of 2010. For estates of decedents who died in 2010, personal representatives could choose new carryover basis rules instead of the estate tax. The 2010 Act implemented a $5 million federal estate tax exemption for 2011 (the actual exemption amount, indexed for inflation, was $5,120,000 for 2012), with a maximum graduated tax rate of 35%. The 2010 Act also provided for something called “portability”, the concept that the estate tax exemption of the first spouse to die, if not utilized, could subsequently be used by the surviving spouse in addition to his or her own estate tax exemption. In essence, the 2010 Act postponed the expiration of many changes brought about under EGTRRA until December 31, 2012, bringing us back to the last quarter of 2012 during which we again anticipated a $1 million federal estate tax exemption as of January 1, 2013, a maximum graduated tax rate of 55%, and no portability. Fortunately, the latter did not occur.
The American Taxpayer Relief Act of 2012 was signed into law on January 2, 2013. Under the 2012 Act, the uncertainties that existed since 2001 appear to be over. With the exception of the estate and gift tax rates, all of the changes enacted during 2010-2012 have now become permanent. This includes a federal estate tax exemption of $5,250,000 ($5 million indexed for inflation) and portability between spouses. This means that a married couple can now exempt $10.5 million. This has implications favoring a simplification of traditional marital deduction planning where a major emphasis of such planning was the utilization of the exemption amount of the first spouse to die. However, even with the advantages of portability, there are many non-tax-related reasons why traditional marital deduction planning will remain an important aspect of comprehensive estate planning. The new maximum graduated tax rate for the federal estate tax is 40%. This represents an increase from the previous maximum rate of 35%.
The gift tax exemption and estate tax exemption were again unified under the 2010 Act with a maximum gift tax rate of 35%. Under the 2012 Act, the gift tax exemption is $5 million (indexed for inflation) and the maximum gift tax rate is also 40%. This means that clients can make lifetime gifts of up to $5 million without incurring gift tax. This is in addition to the annual exclusion (currently $14,000.00 per person per year). One important note – when contemplating lifetime gifts, remember that gifting involves many considerations, including the potential usage of the gift tax exemption and the impact that may ultimately have on the estate at death (taxable gifts in excess of the annual exclusion are added back into the estate at death), Maryland-specific considerations (i.e. Maryland has no gift tax), income tax ramifications, and how the gift should be provided, in trust or otherwise.
In conclusion, let’s return to our 80 year old friend who had just finished his conversation with the nice lady at the fourth floor. Of course, this kind gentleman’s experience was only a dream, so when he awoke from his dream, all of his concerns about the estate and gift tax were resolved with the passage of the 2012 Act, so there was no crisis and nothing further to be concerned about. However, I recognize that there are those of you who wish to know what really happened, so I will tell you – as our friend continued to fall, the nice lady at the fourth floor instantly changed into a super hero, flew out the window, soared below at supersonic speed, and rescued our friend from his fall, eventually flying him back to the roof of the building. Our friend, happy to be safely back where he began, profusely thanked the lady for her assistance, and being somewhat confused about the entire event, eventually asked where he was. The nice lady said, “why you are at IRS headquarters, of course.”
The attorneys at Elville & Associates counsel and advise clients about estate, gift, and income tax issues. If you have questions or concerns about estate planning, elder law, special needs planning, or specific tax matters, please call 443-393-7696 to schedule a convenient time for a consultation.
