Estate Planning and The American Taxpayer Relief Act of 2012

Living TrustAfter years of uncertainty around the gift and estate tax provisions, Congress passed The American Taxpayer Relief Act of 2012 on January 1, 2013.  Among other tax changes, this act brought some permanence to estate planning for Americans.  The intent is to be permanent; however, a future Congress can change the exclusion amount or the tax rate or both.  What is not set to happen is a time when this legislation will expire automatically and revert to a previous schedule, thus the improvement.

The new lifetime gift and estate tax exemption increased to $5,250,000 per person rather than reverting to the $1,000,000 exemption that was set to happen automatically on 12/31/2012 without Congressional intervention.  The exclusion amount is also indexed to inflation in future years.  The top tax rate was increased from 35% to 40% effective 01/01/2013.

A provision which was also made “permanent” was the portability clause.  Previously it was temporary and set to expire.  This provision allows the estate tax exemption to be transferred between spouses.  When the first spouse dies, any unused exemption of the allowable $5,250,000 (in 2013) can be transferred to a surviving spouse so a couple utilizes the combined $10,500,000 allowed.

The Good News:  this is a valuable provision and will help families who have difficulty dividing up their assets to maximize the combined exclusion limit.  It will mean that family farms and family businesses will be able to receive the maximum exclusion allowed without regard to which one in a couple dies first.

The Caution and Planning Tip:  failing to split the ownership of assets between a husband and wife so each one uses his or her full exemption means that any appreciation after the death of the first spouse is in the estate of the second to die.  In traditional planning, Revocable Living Trusts are used to divide up the assets and qualify for the full estate tax exemption while preserving the benefit for the surviving spouse.  The assets in the trust of the first to die are outside the estate of the surviving spouse for estate tax purposes.  Any appreciation on those assets remains outside the estate of the survivor as well.  The Revocable Living Trust is still a very important planning tool.

Without the Revocable Living Trust, and instead planning to use the spousal exemption and portability, when the first spouse dies his or her assets can be transferred to the surviving spouse with no estate tax at the first death.  Then under the portability provision, the surviving spouse may use the full $10,500,000 exemption at his or her death.  However, any appreciation on those assets after the first death will accrue in the estate of the survivor until death.  This could result in a higher estate tax liability for the family than would be due if the Revocable Living Trust strategy is employed.

Estate planning is still a complex area of the tax code and those with a net worth approaching $5,000,000 should seek expert advice from a team of professionals.