THE AMERICAN TAXPAYER RELIEF ACT OF 2012
The American Taxpayer Relief Act of 2012 (“ATRA”)(Pub.L. 112-240, H.R. 8, 126 Stat. 2313) was passed by the United States Congress on January 1, 2013, and was signed into law by President Barack Obama the next day, effective as of January 1, 2013.
ATRA centers on a partial resolution to the United States “fiscal cliff” by preventing the expiration of certain provisions, and allowing the expiration of other provisions, of the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (known together as the "Bush tax cuts"), which had been temporarily extended by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. ATRA also addresses the activation of the budget sequestration provisions of the Budget Control Act of 2011.
ATRA is a compromise measure that prevents expiration of substantial portions of the Bush tax cuts, resulting in no increase in tax rates for certain threshold income levels, and allows the expiration of other portions of the Bush tax cuts, resulting in higher tax rates to certain upper income levels. ATRA establishes caps on tax deductions and credits for certain upper income levels. ATRA also addresses other areas of the income tax code and extension of certain unemployment benefits laws, among other items. Lastly, ATRA addresses some central issues surrounding estate tax and gift tax law.
ATRA does not tackle the debt ceiling, federal spending levels or debt control, instead leaving those matters for further negotiations and future legislation.
The purpose of this letter is to address those specific aspects of ATRA that provide some clarity on the issues surrounding federal estate and gift tax law. This letter does not address any of the income tax issues or other areas of the law affected by ATRA.
ESTATE AND LIFETIME GIFT TAX EXEMPTION AMOUNT
ATRA now makes “permanent” at $5 million (indexed for inflation after 2011) the amount exempted from the estate tax and the gift tax in 2011 (“Applicable Exclusion Amount”). Stated differently, in 2013 the Applicable Exclusion Amount is $5.25M per US citizen (indexed up from $5.12M in 2012 and $5M in 2011). Under ATRA, the available $5M Applicable Exclusion Amount, indexed for inflation after 2011, is now deemed “unified” meaning any US Citizen (“Donor”) can give away/gift up to the Applicable Exclusion Amount ($5.25M in 2013) during life, and the amount of the Applicable Exclusion Amount not given/gifted away by the Donor during life is available to be used on death to shelter the Donor’s remaining assets from estate taxes.
However, all gifts of a Donor that use a portion of his/her Applicable Exclusion Amount (“Lifetime Gift(s)”) will reduce the Donor’s Applicable Exclusion Amount available to the Donor’s estate at death. For example, if a Donor in 2013 makes a $2 million Lifetime Gift, the Donor’s remaining Applicable Exclusion Amount is reduced by $2 million at the death of the Donor. Also, a Donor of any Lifetime Gift must file a Form 709 gift tax return on all Lifetime Gifts made in any calendar year in excess of the annual exclusion amount ($14,000 per Donee in 2013; see below) by April 15 following the calendar year in which the Lifetime Gift was made.
Since the unified Applicable Exclusion Amount ($5.25M in 2013) for estate and gift taxes is indexed for inflation commencing in 2012, the amount of the 2011 base $5M exemption will potentially increase, annually, based on the annual rate of inflation as published in the Federal Register from time to time.
ANNUAL EXCLUSION GIFTS
Under ATRA, the 2013 annual exclusion gift amount is increased to $14,000 per year per recipient (up from $13,000 per recipient in 2012) (“Annual Exclusion Gift”), or $28,000 per couple per recipient. Any gift amount by any Donor to any recipient in any calendar year in excess of the Annual Exclusion Gift ($14,000 in 2013) shall be considered a Lifetime Gift that reduces the Donor’s Applicable Exclusion Amount and requires the filing of a Form 709 gift tax return, all as more fully described above.
Unlike the Lifetime Gift, the Annual Exclusion Gift does not require the filing of a Form 709 gift tax return if given in cash form (unless a split gift is made). Further, any Annual Exclusion Gift made in kind, not in cash form, requires a Form 709 gift tax return with attached appraisal.
GENERATION SKIPPING TRANSFERS AND APPLICABLE EXCLUSION AMOUNT
Under ATRA, the generation skipping transfer tax (GST) exemption available to each US citizen is included within, and a part of, the same unified Applicable Exclusion Amount that exempts each US citizen from estate and gift taxes ($5.25M in 2013). Stated differently, the GST exemption allows any US citizen to preserve his/her Applicable Exclusion Amount ($5.25M in 2013, indexed for inflation) in GST exempt trusts so as to keep his/her assets, including the growth thereon, from being includable in the estate of his/her children/descendants, on their deaths, for estate tax computation purposes.
Maximum Estate/GIFT Tax/GST Rates
Commencing in 2013, the rate for Estate Taxes on transfers in excess of the 2013 Applicable Exclusion Amount ($5.25M per person) is approximately 40%, based on a scaled table. Commencing in 2013, the gift tax on Lifetime Gifts made in excess of the 2013 Applicable Exclusion Amount ($5.25M per person) is this same approximate 40% amount, based on the same scaled table. Commencing in 2013, the generation skipping transfer tax on GST transfers in excess of the 2013 Applicable Exclusion Amount is this same approximate 40% amount, plus an additional penalty of 40%.
Estate and Gift Tax Exclusion Portability.
ATRA continues the concept of "portability," as introduced in 2010 legislation. Thus, if the estate of the first to die of a married couple is not large enough to utilize, in full, his or her Applicable Exclusion Amount, the unused portion can be preserved for use by the surviving spouse.
For example, if the first spouse dies in 2013 ($5.25M Applicable Exclusion Amount) with $3M of assets to fund a bypass trust (also called a “credit shelter trust” or a “family trust”), the $2.25M of his/her Applicable Exclusion Amount that was not needed to fund the bypass/credit shelter/family trust may be transferred to the surviving spouse, giving him/her an Applicable Exclusion Amount of at least $7,500,000 from estate taxes on death (first spouse’s unused and “ported” $2.25M Applicable Exclusion Amount, plus surviving spouse’s $5.25M Applicable Exclusion Amount, indexed for inflation).
In another example, if the first spouse dies in 2013 ($5.25M Applicable Exclusion Amount) with a simple will (and with no bypass/credit shelter/family trust) or intestate that leaves all of his/her $3M of assets to the surviving spouse (using the unlimited marital deduction), the entire unused $5.25M of the Applicable Exclusion Amount of the decedent spouse may be transferred to the surviving spouse, giving the surviving spouse an Applicable Exclusion Amount of at least $10,500,000 from estate taxes (the first spouse’s unused and “ported” $5.25M Applicable Exclusion Amount, plus the surviving spouse’s $5.25M Applicable Exclusion Amount, indexed for inflation).
In other words, under ATRA each married couple is permitted in 2013 to shelter as much as $10.5M from estate tax, indexed for inflation, regardless which spouse dies first or how their assets are titled, and regardless of whether they have any trust documents that create a bypass/credit shelter/family trust on first death, or whether they die with a simple will or die intestate. Keep in mind, however, that to elect portability, the surviving spouse must timely file a Form 706 estate tax return on the estate of the decedent spouse whose unused Applicable Exclusion Amount the surviving spouse wants to “port”. It is important to note that portability is lost if an election is not made by timely filing a Form 706 estate tax return on the estate of the decedent spouse.
Also, even if portability is elected on the estate of the decedent spouse with the timely filing of a Form 706 estate tax return, the portability election is not available to preserve the “ported” unused Applicable Exclusion Amount of the decedent spouse for GST transfer tax exemption purposes. Further, in the event the surviving spouse remarries, the surviving spouse will no longer have access to the unused and “ported” estate tax exclusion of the first deceased spouse on the subsequent death of the new spouse.
Many pundits are expressing the opinion that since ATRA gives the surviving spouse the right to timely elect portability, going forward estate planning practitioners, when preparing estate planning documents for married clients, do not need to plan for the creation and funding of a bypass/credit shelter/family trust on the death of the first spouse to die; according to these same pundits, with portability, a simple trust or a simple will, or even an intestate succession statute, does the job. Nothing could be further from the truth. There are numerous advantages to estate planning documents that create and fund a bypass/credit shelter/family trust at the death of the first spouse to die.
Creating and funding a bypass/credit shelter/family trust on the death of the first spouse to die will potentially reduce the taxable estate of the surviving spouse by keeping the appreciation of the assets of the first spouse to die in the bypass/credit shelter/family trust assets and out of the estate of the surviving spouse. Furthermore, holding the assets of the first spouse to die in a bypass/credit shelter/family trust provides protection from creditors and divorce to the surviving spouse and other beneficiaries of the assets of the first spouse to die that holding the same assets in the survivor’s trust cannot accomplish. Also, because the exemption from GST taxes is not portable, clients wishing to maximize their GST planning for the benefit of their children/descendants must use a bypass/credit shelter/family trust to keep the assets of the first spouse to die GST exempt.
Further, the creation and funding of a bypass/credit shelter/family trust with the assets of the first spouse to die ensures that the surviving spouse will at least capture that portion of the Applicable Exclusion Amount of the first spouse to die equal to the estate of the first spouse, even if the surviving spouse remarries and then that new spouse subsequently dies. Lastly, if Congress subsequently repeals portability, the Applicable Exclusion Amount of the first spouse to die (indexed for inflation) is irrevocably lost if both spouses while alive have not executed trust documents that create a bypass/credit shelter/family trust on the death of the first spouse to die.
STEPPED UP BASIS ON FIRST DEATH MAINTAINED
The Act did not change the law regarding income tax basis adjustment for property acquired from a decedent. Specifically, the income tax basis of non-qualified property acquired from a person as a result of his death is generally stepped up (or down) to its fair market value on the date of decedent’s death, thus eliminating all pre-death capital gain or loss on the property. In the case of marital or community property, both the deceased spouse’s interest in the non-qualified property and the surviving spouse’s interest in the same property qualify for this adjustment.
ATRA IS “PERMANENT”
Many pundits describe the current changes made by ATRA to the estate, gift and GST tax law as “permanent” because these changes are no longer set to expire automatically after a specified period of time -- even though tax laws can and almost certainly will continue to change, going forward, based on the political pressures of changing circumstances. Stated differently, the changes in the estate tax laws codified in ATRA will be “permanent” only as long as Congress does not make further changes. However, nothing in ATRA states that Congress is prohibited from changing the terms of ATRA going forward.
Leaders in both the House and Senate have publicly acknowledged that ATRA is only the first step toward getting the country’s fiscal house in order. As Congress takes its next steps to address our country’s fiscal challenges, additional legislation designed to raise revenue is always possible. This future legislation may include provisions that severely limit the ability to transfer wealth to children and future generations. Upon the passage of ATRA, numerous proposals were tabled that were once seriously considered and certainly may be renewed again: a minimum term for grantor retained annuity trusts (GRATs), term limits for GST trusts, limits on the availability of valuation discounts for a variety of entities (partnerships, LLCs etc.), higher estate and gift taxes, lower Applicable Exclusion Amounts, and estate taxation of intentionally defective grantor trust assets, among other items.
ATRA averted the fiscal cliff, but it did nothing to deal with what is likely to be among the next series of major political battles in Washington: ongoing debt ceiling negotiations and their implications. The debt ceiling is the federal government's authorized borrowing limit and, if circumstances are not radically changed going forward, the national debt ceiling will most likely require periodic and continued extensions. And, each periodic and required extension of the debt ceiling, going forward, will invite new political dialogue on tax policy.
Thus, over time, as the debt ceiling extension negotiations continue to reappear, and as our public borrowing continues to hit the last debt ceiling so negotiated, our nation's leaders will be forced to tackle difficult issues such as defense spending, Medicare and Medicaid spending, changing Social Security benefits, tax reform, and Congressional spending, among other items.
Thus, despite the statements by various pundits that ATRA purports to make estate tax law changes “permanent”, taxpayers should not be lulled into complacency.