In dramatic fashion, Congress adopted its New Year’s tax resolutions just in time to save us from falling off the cliff. The American Taxpayer Relief Act of 2012 (ATRA) passed the Senate in the wee hours of New Year’s morning, and with only one hour left before the day was through, the House joined forces. ATRA addresses a broad array of tax increases that would have occurred had Congress been unable to reach an agreement.
For purposes of estate planning, ATRA extends the inflation-adjusted individual $5 million gift, estate and generation-skipping transfer (GST) tax exemptions that were put in place in 2010. For 2013, these exemptions will now be $5,250,000 per person. However, ATRA increased the highest rate on these taxes from 35 percent to 40 percent. Had Congress been unable to fashion a compromise, the exemption would have fallen to $1 million and the rate would have increased to 55 percent. This prospect caused many clients to put their estate tax planning on the front burner, by moving assets to the next generation in a more tax-efficient manner. With the exemptions remaining at a high level and gradually increasing with inflation, these clients can now consider using new increases in their exemptions for further planning. Meanwhile, those who did not act in 2012 have time to carefully consider tax-favored gifting strategies, including the use of grantor retained annuity trusts, valuation discounts, and unlimited-term generation-skipping trusts, all of which are techniques that could be reduced or eliminated in the upcoming negotiations as Congress attempts to resolve the spending-related elements of the fiscal cliff that ATRA did not address.
ATRA makes “portability” permanent. Portability allows a surviving spouse to use the unused federal estate tax exemption of the first spouse to die, but only if the estate of the first to die files a federal estate tax return. The new law also retains the deduction for state death taxes.
On the income tax side, ATRA reinstates the ability to make a tax-free distribution from an individual retirement plan directly to a qualified charity, an ability that technically expired on December 31, 2011. Because the “charitable rollover” from an IRA was not available in 2012, ATRA includes a special rule permitting a payment made directly to a charity in January 2013 to be treated as a tax-free 2012 distribution from the IRA. Additionally, the same limited window of one month applies to reallocate a December 2012 distribution as though it was originally paid directly to a charity in 2012. In order to accomplish this reallocation, the taxpayer must make a payment in cash to a qualified charitable organization before February 1, 2013 in an amount less than or equal to the amount of the distribution withdrawn in December.
ATRA has a considerable impact on individual income taxes for tax years beginning with 2013, most notably the 39.6 percent income tax rate and the 20 percent rate for dividends and long-term capital gains for individual taxpayers whose taxable income exceeds $400,000, or $450,000 for joint filers, with the 15 percent rate retained for individuals whose income is less than the threshold amounts. ATRA also eliminated the threat to middle-income taxpayers posed by the Alternative Minimum Tax. The new 3.8 percent Medicare Contribution Tax and the 0.9 percent Hospital Insurance Payroll Tax that are part of the Patient Protection and Affordable Care Act, which we discussed in detail in our September 21, 2012 Estate Planning Update, still apply and were not affected by ATRA.
Perhaps most importantly, for the first time in years many tax provisions are no longer enacted on a temporary basis with a set expiration date. Although it is dangerous to believe that these new provisions are really permanent, at least some sense of certainty has returned to the world of estate planning.
Please contact us if you have further questions regarding the implications of the American Taxpayer Relief Act of 2012.