At the end of 2012, the news became dominated by talk about the "fiscal cliff." In short, the fiscal cliff referred to anticipated increase in taxes in 2013 due to the expiration of the 2010 Tax Relief Act which extended the Bush tax cuts and a decrease in spending due to the Budget Control Act of 2011. Without action by Congress, the expiration of the 2010 Tax Relief Act would have caused the 2011 and 2012 estate and gift tax exemption to revert from $5 million to $1 million. This combination of increased taxes and decreased spending would likely have caused a short term negative impact on the U.S. economy, which is currently still struggling.
Towards the end of 2012 with Congress making little progress towards a solution, many people began revising their estate plans in anticipation of the Estate and Gift Tax Exemption reversion. At the last minute, in order to avoid the fiscal cliff, Congress passed the American Taxpayer Relief Act of 2012 (the “Act”), on January 1, 2013. The Act essentially extended the Bush tax cuts, with a few changes.
Who is subject to the federal estate tax? Most estates are not subject to the federal estate tax. The Act extended the federal estate tax exemption of $5 million, with increases for inflation. The exemption for 2012 is $5.12 million and $5.25 million for 2013. The Act prevented the exemption from reverting to the 2001 exemption amount of $1 million and subjecting many more estates to the federal estate tax. For married couples, the exemption amounts may be increased through portability (discussed below). Is should be noted the exemption amount applies to lifetime gifts as well as estates transferred on death.
For example: A single person makes lifetime gifts of $2 million. In order to avoid gift tax on this amount, they use a portion of their estate and gift tax exemption. Their exemption is now decreased to $3.25 million. If they die with $5 million in assets, $1.75 million of the estate would be subject to estate tax. Basically lifetime gifts above the annual exclusion will either be subject to gift tax or reduce the estate and gift tax exemption amount available.
How does this impact married couples? If your spouse is a U.S. citizen you can leave them as much as you want at your death, tax free. A gift to a spouse is treated as a deduction from the gift or estate tax. This is referred to as the marital deduction. Gifts to the spouse may be taxed when the spouse dies, if applicable.
Portability: Another perk for married couples is portability. Under the Act, portability is now permanent which allows a surviving spouse to utilize the unused portion of a deceased spouse's gift and estate tax exemption. (This does not apply to generation skipping taxes.) Portability is permanent but not automatic. The surviving spouse must do some pre-planning to use a deceased spouse's exemption including transferring the exemption and making sure the executor of the first deceased spouse's estate files an estate tax return with the IRS. If none of the exemption has been used, this procedure may provide a surviving spouse with a $10.5 million estate tax exemption rather than $5.25 million. That's a large estate tax free estate.
Here's an example: A couple has a community estate of $3 million. If the first spouse dies and bequeaths all of their community, or $1.5 million, to the surviving spouse, there is no tax on this amount (marital deduction) and none of the first spouse's $5.25 million exemption has been used. With proper planning, the surviving spouse now has a $10.5 million exemption from gift tax on lifetime gifts or on the estate once the surviving spouse dies. If the assets increased to $9 million by the second spouse's death, the estate would pass tax free with the $10.5 million exemption.
Annual Exclusion: The Act does not change the annual exclusion, however due to inflation the annual exclusion amount has increased for 2013 to $14,000. The annual exclusion is excluded from gift tax and allows each person to annually give up to $14,000 to an unlimited number of persons. So, if you have two children and five grandchildren, you could give each of them $14,000 each year for a total of $98,000 per year. The gift must qualify for the annual exclusion, meaning the person receiving the gift must have a "present interest" in the property. Thus, gifts to some types of trusts which restrict the use of funds will not qualify for the annual exclusion, as often the beneficiary does not have a "present interest" in the funds. Crummey Trusts and 529 Plans qualify for the annual exclusion while still placing some restrictions on the use of the funds by the beneficiary.
There is also an unlimited exclusion for payment of tuition and medical expenses when payment is made directly to a provider of medical or educational services.
If you intend to make lifetime gifts in excess of the annual exclusion or believe your estate may be subject to estate tax, it is important to consult an estate planning attorney to determine your options. An attorney can assist you in making the proper gifts and establishing an estate plan which may reduce or eliminate taxes on your death.
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