The American Taxpayer Relief Act of 2012 (the “Act”) was signed into law on January 1, 2013. Among other things, the Act amended the federal estate, gift, and generation skipping transfer tax laws. The amendments of the Act will impact client estate plans in a variety of ways.

 

The Act makes permanent the estate, gift, and generation skipping tax laws that existed in 2012, except that the top tax rate is now 40% instead of 35%. In addition, the exemption amount for estate, gift, and generation skipping tax will be $5,250,000 in 2013. The exemption amount will be increased annually based on inflation. The Act also provides for the continued “portability” of a deceased spouse’s unused exemption amount, the deduction (instead of a credit) against estate tax for the payment of inheritance tax, and the continuation of favorable rules regarding the generation skipping transfer tax and the payment of estate tax related to family business interests.

 

Many clients are concerned with whether their estate plans are “current” because of the Act, or if changes are necessary. Every estate plan – regardless of the tax laws – should be reviewed periodically to ensure that the plan carries out the client’s objectives while at the same time addressing any necessary tax planning.

 

With the passage of the Act, clients should consider the following:

  • Many clients will be able to simplify their estate plans given the increased estate tax exemption amount. For example, “disclaimer” planning and the funding of trusts upon the death of the first spouse may no longer be necessary for the sole purpose of avoiding taxes.
  • Clients who are still impacted by the estate tax will want to consider additional estate planning techniques which avoid or mitigate estate tax exposure. For example, Grantor Retained Annuity Trusts (“GRATs”) are attractive in a low interest rate environment as are transactions involving Intentionally Defective Grantor Trusts (“IDGTs”).
  • Clients who made large gifts in 2012 should review their estate plan to ensure the plan functions properly with the reduced exemption amount that is available to the clients after the large gifts.
  • Due to the higher income tax rates, the 3.8% Medicare tax on investment income, and the limitation on itemized deductions, some clients may want to consider shifting income to children and grandchildren who are in lower income tax brackets.
  • Clients who own assets with significant unrealized gains will want to consider using charitable remainder trusts to avoid the federal capital gains tax and the Medicare tax. Funding a charitable remainder trust also provides a charitable income tax deduction.
  • Certain clients may want to consider unwinding trusts or taking other steps to own highly appreciated assets so there is a basis step up at death (clients will need to weigh the creditor protection offered by a trust against the tax consequences of no basis step up).
  • Clients older than 70.5 years of age may want to contribute up to $100,000 from an IRA to a charity without recognizing any income (this particular aspect of the Act expires at the end of 2013).
  • Clients with Irrevocable Life Insurance Trusts may want to unwind these trusts or take steps to pay up the life insurance policies owned by the trust.

Every estate plan and estate planning client are unique, so the Act will impact each client differently. Some clients, for example, will want to retain income producing assets while gifting non-income producing assets. Other clients, however, may want to unwind trusts while clients may want to continues trusts for tax planning or asset protection reasons.

 

We recommend a periodic review of any estate plan because the law and the client’s circumstances and planning goals change.