Well, happy new year to all. At the 11th hour Congress decided not to let us fall off the Fiscal Cliff by passing the American Taxpayer Relief Act of 2012. But what does that mean in the world of estate planning? There are a number of things that happened (or didn’t happen). So let’s go through each one.
First, the federal exemption for gift and estate taxes was fixed permanently at $5 Million indexed by inflation, instead of reverting back to $1 Million. As of January 2013, that amount became $5.25 Million. This means that you can transfer the first $5.25 Million tax free, whether it was by gifting to people during your lifetime or to your loved ones upon your death. Of course ‘permanent’ just means until Congress changes it.
What about transfers between spouses? The IRS still looks at this as a special type of transfer. They still have what’s called an unlimited marital deduction, meaning you can transfer all of your estate to your spouse tax free, regardless how large it is! Just remember that now the surviving spouse has all of the assets and will be taxed for anything over the exempted amount when he or she dies. Also remember that this marital deduction is only available to spouses who are U.S. citizens.
The second item, which is sort of attached to the first, is that Congress raised the top tax rate on the estate tax from 35% to 40% on the amount that is greater than the exemption. This is still better than the 55% that it was going to go up to had Congress not acted.
The third item is a thing that the legal and financial world has dubbed ‘portability’ of your estate tax exemption. This is another added benefit for married couples. When the first spouse dies, the surviving spouse can elect to add any unused portion of the deceased spouse’s exemption to their own. This would then allow the surviving spouse to transfer up to $10.5 Million if the deceased spouse did not use any of his or her exemption.
Remember that portability of the deceased spouse is not automatic. The administrator of the deceased spouse’s estate must file an estate tax return for the deceased spouse, even if no tax is due. This return is due nine months after death with a six-month extension allowed. If the administrator doesn’t file the return or misses the deadline, the spouse loses the right to portability. Surviving spouses should file it even if they’re not wealthy today, because who knows what the future holds.
What about making a gift during your lifetime? Not everything is taxed, or counted against your $5 Million exemption. Every person has an annual exclusion. As of January 2013, that amount went up to $14,000. This means that you can literally stand on the street corner and give every person who walks by $14,000 and never have to tell the government about it. Now I don’t necessarily recommend doing that, but you can if you want, without paying any taxes and without telling the IRS. Anything above the $14,000 has to be reported to the IRS. They will keep tabs to see if and when you go over your $5 Million lifetime exemption.
There’s one other thing that I need to remind everyone about. Although the federal estate tax exemption has been locked in at $5 Million, New York State estate tax exemption is only $1 Million. The tax rate varies but averages around 10%-12%. So, for a $5 Million estate there may be no federal tax due, but your heirs might be paying New York up to $500,000 in taxes. New York doesn’t have any gift tax so there are ways to minimize, if not eliminate, the estate tax with proper planning.