Tag Archives: Estate Tax

What’s Up With The Estate Tax?

That’s the $5 mil­lion question.

More pre­cisely, for 2012, it’s the inflation-adjusted $5,120,000 question.

If you’ve fol­lowed the wran­gling over the estate tax for the past 10 or 15 years, you know that it is a highly-charged polit­i­cal issue.  It lies directly along the fault line that sep­a­rates the anti-tax enthu­si­asts in Congress from those who believe that the wealthy aren’t pay­ing enough taxes.

The life­time exclu­sions from the fed­eral gift and estate taxes have increased con­sid­er­ably over the past sev­eral years.  As a result, for the present time at least, fed­eral gift and estate taxes have been elim­i­nated as a con­cern for the mid­dle class.  A mar­ried cou­ple may now trans­fer $10,240,000 to their chil­dren with­out pay­ing fed­eral gift or estate taxes.  I assume that to most Americans, cou­ples who have $10 mil­lion to pass along to their chil­dren aren’t exactly mid­dle class.  Others may define “mid­dle class” more broadly and argue that a cou­ple own­ing $10 mil­lion in assets is merely “com­fort­able,” but not wealthy.

In any case, whether you believe that today’s $5 mil­lion per per­son life­time exemp­tion ($10 mil­lion per mar­ried cou­ple) is too high, too low or “just right,” those fig­ures are des­tined to expire at the end of 2012.  Unless Congress acts, the gift and estate taxes will revert to the laws that were in effect in the year 2001.  That means only a $1 mil­lion per per­son ($2 mil­lion per mar­ried cou­ple) life­time exemp­tion from the fed­eral gift and estate taxes.  (The life­time exemp­tion from the third wealth trans­fer tax, the Generation-Skipping Transfer Tax (GSTT), will be a some­what larger num­ber, since the $1 mil­lion GSTT exemp­tion was indexed for infla­tion under the law in effect in 2001.)

What is espe­cially dis­con­cert­ing about the fluid state of the wealth-transfer taxes is that plan­ning to reduce or avoid the taxes is chal­leng­ing at best.  Anecdotally, many fam­i­lies have resisted updat­ing their estate plans for years, wait­ing for Congress to agree on and stick to life­time exclu­sions and tax rates (which have them­selves declined sub­stan­tially since 2001) for the gift and estate taxes and the GSTT.

A bit of his­tory is in order.  In 2001, Congress passed and President Bush signed into law the Economic Growth and Taxpayer Relief Reconciliation Act (EGTRRA).  EGTRRA grad­u­ally increased the life­time exemp­tions from the estate tax and GSTT until they reached $3.5 mil­lion in 2009.  The rates for both taxes were like­wise grad­u­ally reduced from mar­ginal rates that could reach as high as 60% for the estate tax to a max­i­mum mar­ginal rate of 45% for each tax.

Under EGTRRA, the estate tax and GSTT were slated to expire in 2010.  Because of bud­getary con­straints and Senate bud­get rules which would have required an unat­tain­able 60 votes to per­ma­nently repeal the taxes, the repeal was for one year only.  In 2011, the pre-EGTRRA taxes would be rein­stated as they existed in 2001, as though EGTRRA had never been signed into law.  The evi­dent inten­tion was that both taxes would be per­ma­nently repealed by a later and more sym­pa­thetic Congress.

EGTRRA did not repeal the fed­eral gift tax.  This omis­sion was intended to pre­vent fam­i­lies from gam­ing the sys­tem for income tax pur­poses by gift­ing assets to those best able to uti­lize the assets’ income tax attrib­utes, espe­cially unused cap­i­tal gains and losses.

Of course, there was lit­tle doubt that Congress would revisit the wealth-transfer taxes to avoid the absur­dity of a one-year repeal of the estate tax and GSTT, fol­lowed by their revival in 2011 with much lower exemp­tions and much higher tax rates than had been in place in 2009.

Congress sur­prised every­one by fail­ing to effec­tively address EGTRRA prior to 2010.  Only in December of that year did Congress act, serv­ing up a leg­isla­tive hash that gave the estates of per­sons who had died in 2010 the option of pay­ing an estate tax or pay­ing income tax on untaxed cap­i­tal gains in the decedent’s estate.  In other words, car­ry­over basis would replace the basis step-up at death.

In the 2010 tax act (the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010) (TRUIRJCA), President Obama agreed with Republican lead­ers to rein­state all three of the wealth trans­fer taxes, each with a life­time exemp­tion of $5 mil­lion (adjusted for infla­tion begin­ning in 2012) and a max­i­mum tax rate of 35%.  As indi­cated above, for 2012, the inflation-adjusted exemp­tions are set at $5,120,000.  The TRUIRJCA accord, how­ever, expires at the end of 2012.  At that time, as was the case with EGTRRA, the wealth trans­fer taxes will revert to year 2001 life­time exemp­tions and tax rates.  Will Congress finally act and give us the sta­bil­ity in the law that will per­mit American fam­i­lies to plan for reduc­ing and pay­ing the wealth trans­fer taxes?

It’s been a long road get­ting from 2001 to where we are today.  Sadly, how­ever, that’s not the fin­ish line you see up ahead; it’s the start­ing line.  We’re back to where we began, not know­ing what the law is going to be from one year to the next.


It’s Gifting Time Again!

One of the most effec­tive estate plan­ning tools for per­sons look­ing to reduce their estates for gift and estate tax pur­poses is to make “annual exclu­sion” gifts each year to their loved ones in lower gen­er­a­tions. Typically, such gifts are made in January. In this way, should the donor pass away later in the year, the oppor­tu­nity to make annual exclu­sion gifts will not have been lost.

The annual exclu­sion is the largest amount that an indi­vid­ual can give in any par­tic­u­lar year to each of their loved ones with­out incur­ring fed­eral gift taxes or reduc­ing their life­time exemp­tion from gift and estate taxes. (The life­time exemp­tion, known tech­ni­cally as the “applic­a­ble exclu­sion amount,” is the aggre­gate amount that an indi­vid­ual may give dur­ing life­time and at death with­out incur­ring fed­eral gift or estate taxes.) The annual exclu­sion is indexed for infla­tion so it increases in amount in some years. This year, how­ever, the IRS has announced that the annual exclu­sion will remain at $13,000, the same fig­ure it has been since 2009.

To demon­strate the power of annual exclu­sion gifts, sup­pose that a mar­ried cou­ple in their six­ties has four adult chil­dren, all of them mar­ried, and ten grand­chil­dren in all. Each grand­par­ent can make an annual exclu­sion gift to each of their four chil­dren, their children’s four spouses (if desired), and their ten grand­chil­dren. That amounts to eigh­teen annual exclu­sion gifts per grand­par­ent, or thirty-six gifts in total. Multiplied by the annual exclu­sion amount of $13,000, those thirty-six gifts will reduce the grand­par­ents’ com­bined estates by $468,000 in a sin­gle day with­out any adverse gift or estate tax consequences.

If one spouse is wealthy and the other is not, the wealthy spouse can make all of the gifts and, with their spouse’s con­sent, treat the gifts as made one-half by each of them. (This is referred to as “split­ting gifts.”) As a result, the non-wealthy spouse can in effect make annual exclu­sion gifts that they oth­er­wise could not afford.

Gifts between spouses are usu­ally dis­re­garded for gift and estate tax pur­poses, a con­se­quence of the gift and estate tax unlim­ited mar­i­tal deduc­tion. An excep­tion arises, how­ever, if one of the spouses is not an American cit­i­zen. Gifts by an American cit­i­zen to their spouse do not qual­ify for the mar­i­tal deduc­tion. Instead, to par­tially com­pen­sate for the loss of the mar­i­tal deduc­tion, gifts to a non-citizen spouse are sub­ject to an aug­mented annual exclu­sion amount. For 2012, that fig­ure is $139,000, up from $136,000 in 2011. Gifts not exceed­ing $139,000 will there­fore be dis­re­garded for gift and estate tax purposes.

Of course, as the law stands today, rel­a­tively few peo­ple need con­cern them­selves with fed­eral gift and estate taxes because the life­time exemp­tion from those taxes (for American cit­i­zens and non-citizens who are domi­ciled in the US) stands at $5,120,000 per per­son. However, this is a tem­po­rary arrange­ment between Democrats and Republicans in the nation’s cap­i­tal, a polit­i­cal stale­mate. New laws are sup­posed to be in place effec­tive January 1, 2013. What those laws will pro­vide no one can say.

Be aware that most states also impose estate or inher­i­tance taxes, and a few even impose gift taxes. New York has no gift tax, and the exemp­tion from estate taxes is fixed at $1,000,000. The max­i­mum estate tax rate in New York is 16%. With very high fed­eral exemp­tions in place, the focus in estate plan­ning is shift­ing from fed­eral to state estate and inher­i­tance tax savings.