Ringing in the New Year with Revised Estate and Gift Tax Laws

by Manatt, Phelps & Phillips, LLP

Congress has averted the so-called fiscal cliff by passing the "American Taxpayer Relief Act of 2012" (the "Act") on January 1, 2013, which President Obama signed into law the following day.  The good news is we finally have certainty with respect to gift, estate and generation-skipping transfer taxes.

For a number of years the federal estate, gift and generation-skipping tax laws have been in a state of uncertainty, which made planning for these taxes extremely difficult.  Prior to the Act's passage, the estate tax exemption was $5 million per person (indexed for inflation after 2011), and the top tax rate was 35%.  Under the prior law, however, this $5 million exemption was set to decrease as of January 1 to $1 million, with a top tax rate of 55%.  By passing the Act, Congress permanently set the estate tax exemption at $5 million per person (indexed for inflation after 2011), with a top tax rate of 40%.  For 2013 this means the estate tax exemption has increased to $5,250,000.  In addition, the exemptions from gift tax and generation-skipping transfer tax ("GST Tax") are unified with the estate tax exemption.  The gift tax rates mirror the estate tax rate schedule with a top tax rate of 40%, and the GST Tax rate is a flat 40%. 

The significant decrease in the estate tax and gift tax exemptions originally scheduled for January 1, 2013, precipitated a flurry of large gifts by individuals in 2012 to take advantage of the larger exemption amounts before they expired.  In hindsight, given recent congressional action, it may seem that the hurried timing of such gifts was unnecessary; however, the gifts may ultimately save families significant future estate taxes.  By making these significant gifts in 2012, the donees effectively removed the gifted property and the appreciation on the gifted property from their estates.  In fact, individuals who made $5,120,000 in gifts before the new year may wish to consider making additional gifts in order to fully utilize their lifetime gift tax exemption now that it has been adjusted for inflation.  In addition, as under prior law, annual exclusion gifts also can be made to any individual each year free of gift tax without impacting the donee's lifetime gift tax exemption.  The annual gift tax exclusion for 2013 is $14,000 per donor per donee (this represents an increase from $13,000 in 2012).

In addition to the changes noted above, portability was made permanent under the Act.  Portability allows a surviving spouse to make use of a deceased spouse's unused estate tax exemption.  Relying on portability is not often the best way to make use of a married couple's estate tax exemptions, but it can act as a safety net to save the deceased spouse's unused exemption if no formal estate planning has been completed prior to the first spouse's death.

For those who have been hesitant in the past to make significant gifts because of the uncertainty in the law, the "permanent" estate and gift tax exemptions and rates (without sunset provisions on the horizon) may be a welcome relief.  However, as we have recently observed, the thresholds established by Congress may be changed at any time.  In addition, although not addressed under the Act, President Obama and other congressional leaders have expressed interest in curtailing the benefits of various popular estate planning strategies used to reduce the value of gifted or retained assets, including limitations on (or the elimination of) lack of control and marketability discounts for family-owned business entities, limitations on (or the elimination of) sales to defective grantor trusts, and the modification of terms for grantor-retained annuity trusts ("GRATs").

Therefore, if you didn't join the gifting rush at the end of last year, 2013 presents an excellent opportunity to review your overall plan with your estate planning advisor and to make substantial discounted gifts to reduce the ultimate value of your taxable estate.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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