As 2012 drew to a close, your estate planning attorney's attention was diverted from the ball drop in Times Square to whether Congress would drop the ball with respect to the fiscal cliff. Congress, however, passed the American Taxpayer Relief Act of 2012 ("ATRA"), which became law on January 2, 2013, when it was signed by President Obama.
Absent ATRA, the exemptions provided by the federal tax law for gift tax, estate tax and generation-skipping transfer tax ("GST") of $5,120,000 would have returned to pre-2001 levels. ATRA has made permanent the gift tax, estate tax and GST exemptions, which will be indexed annually for inflation. In 2013, the amount exempt from each of such taxes is $5,250,000.
ATRA also made permanent portability between spouses so that a surviving spouse will be able to use any remaining exemption of the deceased spouse.
The top tax rate on transfers subject to the gift tax, estate tax and GST tax has increased from 35% to 40%.
So was it worth the scramble to make gifts in 2012 now that the higher exemptions have been made permanent? Absolutely. It always makes sense to make gifts during one's lifetime (assuming one can afford to make the gifts) because:
A gift will shift future appreciation and income out of the donor's taxable estate.
Paying gift tax is actually tax-efficient as the gift tax is imposed only on the property that is given away, whereas the estate tax is imposed on all the property in the estate. The effect is that if the donor survives at least three years after the gift, the amount of the gift tax will not be subject to estate tax. For example, if in 2013 Fred, a widower whose estate is worth $16.5 million and who has already used his lifetime exemption, gives $1.5 million to his daughter Frieda, the gift tax would be $505,800. If Fred survives three years, the $505,800 paid in gift tax is not part of his estate for estate tax purposes. The tax savings of making the gift is 40% of the gift tax, or about $200,000.
Many states, including New York and New Jersey, do not have a gift tax. Lifetime gifts in these states can reduce state estate taxes. Many states have significantly smaller estate tax exemptions compared with the federal exemption. New York and Massachusetts have an estate tax exemption of $1,000,000, New Jersey has an estate tax exemption of $675,000, and Connecticut has an estate tax exemption of $2,000,000.
ATRA did not include proposed limitations on certain estate planning strategies, some of which have been under scrutiny for the past several years. At least for now, strategies such as a grantor retained annuity trust ("GRAT"), discounting the value of minority interests in family-controlled entities, and "grantor trusts," which allow the grantor to make gift tax-free gifts to the trust beneficiaries by paying the trust's income tax liability, remain weapons in an estate planner's arsenal.
For taxpayers over age 70½, ATRA extended through December 31, 2013, the ability to make charitable contributions of up to $100,000 directly from the taxpayer's individual retirement account ("IRA"). The amount distributed to charity will not be included in gross income and will satisfy the required minimum distribution. In addition, a taxpayer may elect to treat (i) a qualified charitable distribution made from an IRA after December 31, 2012, and before February 1, 2013, as if made on December 31, 2012, and (ii) a distribution from an IRA to a taxpayer after November 30, 2012, and before January 1, 2013, as a qualified charitable distribution if such distribution is transferred in cash to a qualified charitable organization before February 1, 2013.
2013 Inflation Adjustments
In addition to changes made by ATRA, the following inflation adjustments apply in 2013:
The annual gift tax exclusion has increased from $13,000 to $14,000 per donee.
The annual gift tax exclusion for gifts to noncitizen spouses has increased to from $139,000 to $143,000.
The amount at which gifts received by a U.S. taxpayer from foreign corporations and partnerships must be reported to the IRS has increased from $13,258 to $15,102. Gifts from foreign individuals are not indexed and must be reported if at least $100,000.
The annual short-term, midterm and long-term interest rates as set by the Treasury for January 2013 are .21%, .87% and 2.30%, respectively. Those for February are .21%, 1.01% and 2.52%, respectively. These are the minimum rates set by the Treasury that must be charged on transactions between related individuals to avoid the imputation of interest.
The January 2013 Section 7520 rate is 1% and that for February is 1.20%. This rate is used to calculate the value of certain transfers such as a GRAT, charitable lead trust or charitable remainder trust. Growth beyond this "hurdle" rate generally accrues to the donee.
The current low rates provide attractive estate planning opportunities with respect to GRATs, charitable lead annuity trusts, installment sales and intra-family loans.
IRS Circular 230 Disclosure: To ensure compliance with Treasury Department regulations, we inform you that any U.S. federal tax advice contained in this document (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the U.S. Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.