The American Taxpayer Relief Act of 2012 (generally referred to as the “2012 Taxpayer Relief Act”),
was signed into law by the President on Jan. 2, 2013. The 2012 Taxpayer Relief Act prevents many of
the tax hikes that were scheduled to go into effect in 2013 and retains many favorable tax breaks that were scheduled to expire.
A detailed review of all of the changes in the tax rules is beyond the scope of this letter. What follows is: 1) a review of the new rules that generally relate to estate planning, 2) a review of some of the other fundamental tax planning rules that continue to apply to estates, and 3) some
commentary on how these rules may impact your estate planning.
For those who want the “short version”, most of the specific provisions in the new law that are reviewed in this letter are in bold-italics.
First, for the first time in over 10 years, the estate, gift and generation skipping tax laws are not scheduled to expire in the future. We can finally have some certainty about the tax laws that will apply to estates. This will allow us to analyze and project with more certainty, the impact of estate taxes on each client’s estate.
The Federal Estate Tax Exemption. The new estate tax law provides for an inflation adjusted estate tax exemption. In 2012, the per-person estate tax exemption was %5.12 million. It is anicipated that the inflation adjusted estate tax exemption for 2013 is $5.25 million.
The federal generation skipping tax is a tax on transfers to grandchildren and more remote descendants. The generation skipping tax is also estimated to be $5.25 million in 2013, and adjusted for inflation in the future.
Portability. In 2010, the concept of estate tax exemption portability was introduced into the tax law, and the new law has made portability permanent. Portability permits the surviving spouse to utilize the remaining unused estate tax exemption of the deceased spouse. Assuming a $5.25 million per-person federal estate tax exemption, this means a married couple can transfer up to $10.5 million free of federal estate tax. However, portability is not automatic. The Personal Representative handling the estate of the spouse who died will need to transfer the unused exemption to the surviving spouse by filing a timely filed estate tax return when the first spouse dies, even if no tax is owed. This return is due nine months after death with a six-month extension allowed. If the Personal Representative doesn’t file the return or misses the deadline, the opportunity to use portability is lost.
Portability is a powerful tool for married couples and provides significant flexibility to help reduce or eliminate federal estate taxes. Portability is an element of a thoughtful plan; it is not a justification to ignore thoughtful planning with respect to estate taxes. Allow me to offer some brief examples. First, as mentioned above, portability must be activated by filing a timely filed estate tax return. Those who fail to plan and identify where portability will be utilized will be at risk of never being aware of the necessity to file the tax return. Second, the Maryland estate tax and the federal generation skipping tax do not permit portability of the deceased spouse’s exemptions from those taxes. In order to plan to reduce these taxes, planning techniques other than portability must be utilized.
One area where portability provides an excellent planning opportunity is for married couples who have a significant portion of their assets in retirement accounts, such as IRAs and 401Ks. For married couples in such circumstance, they were previously forced to decide between designating a
By-Pass Trust as the primary beneficiary of the accounts, and designating the surviving spouse
as the primary beneficiary. The analysis for this decision is rather complex, and forces couples to choose between reducing estates and deferring income taxes on the retirement accounts. The details of this analysis are beyond the scope of this letter. However, under the new portability rules, a married couple is no longer forced to choose between estate tax savings and income tax deferral on retirement accounts. Under the portability rules, by designating the surviving spouse as the primary beneficiary of the retirement accounts and filing an estate tax return upon the death of the first spouse to utilize portability, a married couple may reduce estate taxes and also plan to defer income taxes on retirement accounts for their descendants.
Married couples should consider how to use portability when designing their estate planning. In addition, the Personal Representative of every married decedent should carefully consider whether an estate tax return should be filed to transfer the estate tax exemption of the deceased spouse to
the surviving spouse.
Gift Taxes. The lifetime federal gift tax exemption is the same as the federal estate tax exemption, estimated to be $5.25 million in 2013. The federal estate and gift taxes are unified”. This means as a donor makes gifts during his or her lifetime, the donor’s gift and estate tax exemption will be reduced. Once the total lifetime gifts exceed the lifetime gift tax exemption, the donor will be required to pay gift taxes on such gifts. For example, if a donor gives $1 million to his son in 2013, the donor’s gift tax exemption and estate tax exemption will be reduced by the amount of the $1 million gift. The IRS keeps track of one’s lifetime gifting by requiring the filing of federal gift tax returns. Each time a taxpayer makes a gift, he or she must file a federal gift tax return by April 15 of the year following gift. The gift tax return serves to report the value of the gift and track the emaining estate and gift tax exemption.
Gift Tax Rule Exceptions. There are a number of exceptions to the requirement of filing a federal gift tax return. For example:
In 2013, each donor may gift up to $14,000 per donee without the requirement of filing a gift tax return or reducing the lifetime gift or estate tax exemption.
- Gifts to one’s spouse, of any amount, do not require a gift tax return or reduction of the lifetime gift or estate tax exemption.
- Certain gifts paid on behalf of the donee for the medical expenses of the donee and gifts for the tuition expenses made directly to a qualified educational organization do not require a gift tax return or reduction of the lifetime gift or estate tax exemption.
- Gifts to qualified charities do not require a gift tax return or reduction of the lifetime gift or estate tax exemption.
The rules relating to qualifying for an exception from gift taxes can sometimes be more complicated than as described above. It is advisable to seek counsel with respect to qualifying gifts for an exception from the gift tax.
The Estate and Gift Tax Rate. The new tax rate applicable to federal estate, gift and generation skipping taxes is 40%. This reflects an increase from the 35% rate applicable in 2012.
The Maryland Estate Tax. The Maryland estate tax rules are unchanged from 2012. The Maryland estate tax applies to Maryland residents and to persons who die owning real property in Maryland. Estates valued less than $1 million continue to be exempt from the Maryland estate tax. The tax rate on estates that are greater than $1 million but less than $1.3 million is initially 16%. The marginal Maryland estate tax rates decrease as the value of the estate increases. Portability does not apply to
the Maryland estate tax. There is no g ft tax under Maryland law, and lifetime gifts do not reduce the Maryland estate tax exemption.
Tax Free IRA Distributions to Charity. The IRA distribution rules allow for the tax-free treatment of distributions from IRAs where the distributions are donated to charity. Specifically, a taxpayer who has attained the age of 701/2 may exclude from gross income so much of the aggregate amount of his “qualified charitable distributions” not exceeding $100,000 in a tax year. In order to qualify under this special rule, the charitable contribution must be made directly from the IRA Trustee to the qualified charity. Further, an IRA owner who makes an IRA qualified charitable distribution in an amount equal to his Required Minimum Distributions for the tax year is considered to have satisfied his minimum distribution requirement for that year, even though a charitable entity
(and not the IRA owner) is the recipient of the distribution. This rule only applies to IRA distributions
made before January 1, 2014.
Capital gains and qualified dividends rates. Beginning in 2013, the long-term capital gains and qualified dividends rate will be 0% if income falls below the 25% tax bracket; 15% if income falls at or above the 25% tax bracket but below the new 39.6% rate; and 20% if income falls in the 39.6% tax bracket.
It should be noted that the 20% top rate does not include the new 3.8% surtax on investment-type income and gains for tax years beginning after 2012, which applies on investment income above
$200,000 (single) and $250,000 (joint filers) in adjusted gross income. So actually, the top rate for capital gains and dividends beginning in 2013 will be 23.8% if income falls in the 39.6% tax bracket. For lower income levels, the tax will be 0%, 15%, or 18.8%.
What action should you take? The good news is that the estate and gift tax exemptions have not been reduced, as was widely anticipated. As a result, for many people, changes to their estate
planning documents may not be necessary. For families with combined estates valued at less than $1 million, it is unlikely that these tax law changes require changes to your planning documents. For others, changes to one’s estate planning documents are not as urgent as would have otherwise been.
It will be necessary to continue to use the By-Pass Trust to reduce the Maryland estate tax for a married couple. However, some married couples may amend their planning documents to limit the amount of property transferred to the By-Pass Trust upon the death of the first spouse. So changes will be based on the decision to plan to rely on portability (rather than the By-Pass Trust) to eliminate federal estate taxes. Although the By-Pass Trust may no longer be necessary to reduce the federal estate tax, the By-Pass Trust provides other benefits that should be considered before increasing reliance on portability. For example, assets in a By-Pass Trust are not subject to probate upon the death of the surviving spouse, and the By-Pass Trust provides better asset protection than outright
ownership by the surviving spouse. The By-Pass Trust may also be the preferred method for asset management during the incapacity of the surviving spouse. Finally, for those families planning to preserve their assets for grandchildren and future generations, the By-Pass Trust is likely preferable to relying on portability when planning for the generation skipping tax.
As is always the case with estate planning, there is no one answer that will apply to all. If you would like to meet to consider how the new law will impact your estate plan, please feel free to call my office to schedule a meeting. It will be important that you bring a current list of your assets to that meeting. You may ask my office to send you an Asset Summary, or you may download an Asset Summary Form by clicking on “Becoming a Client” at our website; www.HoldenCampbell.com.
We hope you find this helpful and we wish you a healthy and happy 2013.
Holden & Campbell, LLC Annapolis Estate Planing Attorneys
By-Pass Trust – also known as a Family Trust, Residuary Trust or Credit Shelter
Trust, is a trust included in estate planning documents and funded at the death
of the first spouse to die to utilize the remaining estate tax exemption of the
first spouse to die and ultimately reduce estate taxes upon the death of the