February 17, 2015
On January 2nd, 2013, President Obama signed into law the “American Taxpayer Relief Act of 2012,” passed by the House as H.R. 8 as a result of the so-called “fiscal cliff” negotiations. In addition to raising income tax rates on “high-income” earners, the act permanently extends the estate and gift (and generation-skipping) tax relief provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) as modified by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which would have expired on January 1, 2013. Absent Congressional action, the estate and gift tax exemptions would have returned to $1,000,000 (as indexed for inflation), with the top tax rate returning to 55% (from 35%).
This Notice summarizes the provisions of the 2012 Act pertaining to estates, gifts, and generation-skipping transfers. You should consult with your accountant with respect to whether or how the income tax provisions of the 2012 Act may affect you.
Please be aware that this information is intended to be general and does not constitute tax advice. You should seek tax advice based on your particular circumstances, rather than rely on the general statements contained in this Notice. Circular 230 Notice: None of the information contained herein is intended to be used, nor can it be used, for the purpose of avoiding US tax penalties.
The Federal Estate Tax:
The federal estate tax “applicable exclusion amount” (or exemption) is “permanently” set at $5 million, indexed for inflation. (The exemption, as adjusted for inflation, is $5,430,000 for 2015). The maximum tax rate is increased from 35% to 40%, for estates of persons who die in 2013 or beyond. The 40% rate applies for taxable estates or gifts over $1 million.
An automatic step-up in basis will apply, and the basis in the hands of the estate’s beneficiaries will be the fair market value as of the date of death.
“Spousal portability” is made permanent. “Spousal portability” refers to the ability of a surviving spouse to elect to use the unused exemption amount of a predeceased spouse. This first appeared in the 2010 Act, and was set to expire in 2013. For example, if husband died in 2012 with an estate of $3 million, his executor could elect to make available to his surviving spouse his unused exemption of $2,120,000 million, in addition to whatever exemption is available to her, on her death, or to make lifetime gifts. The election must be made by the executor of the estate on a timely filed federal estate tax return (Form 706), even if an estate tax return is not otherwise required to be filed.
The deceased spouse’s unused exemption amount is available to the surviving spouse so long as the deceased spouse is the surviving spouse’s “last” deceased spouse. It is available to the surviving spouse even if the spouse remarries, so long as the surviving spouse’s second spouse has not died. Once the surviving spouse’s second spouse dies, the first deceased spouse’s unused exemption amount is no longer available. In addition, the 2012 Act clarifies the wording of the 2010 Act to enable a subsequent spouse of a surviving spouse who has made the portability election on the death of her or her deceased spouse to benefit from the deceased spouse’s unused exemption amount upon the death of the surviving spouse.
For example: Husband dies in January of 2011 with an estate of $3 million. His executor elects portability with respect to his unused exemption amount of $2 million. His surviving spouse remarries, and dies in December of 2011 with a taxable estate of $4 million. Her applicable exclusion amount is $7 million (her $5 million basic exclusion amount, plus $2 million of her deceased spouse’s unused exemption amount). Her executor files a federal estate tax return to elect spousal portability. Her surviving spouse (Husband 2) has available to him, upon his death or for lifetime gifts, his own basic exclusion amount of $5 million, as indexed for inflation, plus his deceased wife’s unused exemption amount of $3 million, for a total of over $8 million.
Spousal portability is not a substitute for traditional estate planning for those individuals or couples with combined assets in excess of the applicable state or federal exemption amounts. Rather, it provides statutory relief for persons who have not undertaken traditional estate planning. Reliance on spousal portability, rather than a traditional “credit shelter trust” or other estate planning arrangement, has several disadvantages. First, the generation-skipping transfer tax exemption of the deceased spouse is not portable. Second, the portability election does not protect appreciation on property from being taxed in the surviving spouse’s estate, while a traditional credit shelter trust does protect appreciation of assets from taxation in the survivor’s estate. And there are many non-tax reasons for estate planning with trusts, including preserving assets for children of a prior marriage, protecting spendthrift beneficiaries, providing professional investment and management of assets, and protecting minor or disabled beneficiaries. On the other hand, portability may provide an opportunity for step-up in basis on the death of the surviving spouse, as well as that of the deceased spouse. The relative income and estate tax rates applicable to specific assets will have to be taken into account in undertaking estate planning.
The Federal Gift Tax:
The gift tax exemption for 2013 and beyond (unified with the estate tax) is $5 million, indexed for inflation, ($5.43 million for 2015) with a maximum tax rate of 40% on taxable gifts over $1 million.
The “spousal portability” election permits a surviving spouse to utilize the unused exclusion amount of a deceased spouse to make taxable gifts. An “ordering” rule applies, so that a surviving spouse whose deceased spouse’s executor has made the portability election (by filing a federal estate tax return) is deemed to have used the deceased spouse’s remaining exemption in making taxable gifts prior to using his or her own exemption.
The Federal Generation-Skipping Transfer Tax:
The generation-skipping transfer tax exemption is also permanently set at $5 million, as indexed for inflation ($5,430,000 for 2015), with transfers in excess of the exemption taxed at a rate of 40% (on top of the applicable estate or gift tax rate). Several advantageous provisions of EGTRRA, such as automatic allocation of GST tax exemption, are permanently made a part of the tax law. (Like portability, automatic allocation is intended to provide relief to taxpayers whose tax preparers failed to make allocation of GST exemption to generation-skipping gifts or transfers at death.)
The Connecticut Estate (and Gift) Taxes:
Keep in mind that the unified exemption from Connecticut estate and gift taxes remains at $2 million, with a maximum tax rate of 12%. Connecticut has repealed its generation-skipping transfer tax.
The Tax Increase Prevention Act of 2014, signed into law on December 19, 2014, extends certain charitable provisions through December 31, 2014. Donors (and charities) will be left wondering whether these (and other) charitable giving provisions will be temporarily extended again for 2015, or made permanently a part of the tax law.
- The Act extends the availability of the charitable IRA rollover through 2014. This permits direct gifts to certain charities (the requirements are summarized in the Pension Protection Act notice).
- The deduction limitation for qualified conservation easement contributions is increased to 50% rather than 30%, as under prior law, through 2014.
Existing estate plans containing a credit shelter disposition should be reviewed with respect to the federal exemption of over $5 million (as indexed for inflation). A “formula” plan passing the amount that can pass free of federal estate tax to a “family” or “credit shelter” trust, or directly to children, will now result in over $5 million in assets passing to the family or credit shelter trust, or to children, and may result in no assets passing outright to a surviving spouse. Plans that were based on the amount passing free of both Connecticut and federal estate taxes will pass only $2 million to the “credit shelter” trust or gift. Some taxpayers may decide to incur Connecticut estate or gift tax in order to shelter a greater amount from federal estate tax on the death of the surviving spouse.
If your estate plan consists of a “disclaimer” trust or a “single QTIP” trust for the surviving spouse, some flexibility in dealing with differing exemption amounts is built into the plan. Your spouse, or your executor, can determine whether to disclaim, or make a marital deduction election, based on the state and federal exemption amounts in effect at the time of your death.
If your combined assets exceed $2 million, you should not necessarily rely on “spousal portability” in simplifying your estate plan and leaving all your assets to your spouse. However, if assets pass to a surviving spouse and the taxable estate of the deceased spouse is below the applicable exclusion amount, serious consideration should be given to making the portability election by filing a timely federal estate tax return. A surviving spouse should consider making taxable gifts to utilize a deceased spouse’s unused exemption amount, especially if re-marriage is contemplated.
Traditional estate planning techniques, such as utilizing annual exclusion gifts (the annual exclusion is increased from $13,000 to $14,000 for 2013, adjusted for inflation, and remains at $14,000 through 2015), irrevocable life insurance trusts, and credit shelter trusts, or disclaimer plans, remain applicable for those individuals or couples with combined estates of $2 million or more. Other states may have lower exemption amounts (and higher rates), but no gift taxes, so consideration should be made to making lifetime gifts of out-of-state real estate in order to avoid paying state estate taxes on the out-of-state real property at death.