The United States Revenue Act of 1916 instituted the federal estate tax. Since then, the rates and exemptions granted to taxpayers have changed significantly. From 2001 to 2010, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) gradually increased the estate tax exemption, while lowering the top taxable rates. By 2009 the estate tax exemption had risen to $3,500,000 with a top tax rate of 45 percent. In 2010 the estate tax was scheduled to be eliminated under the terms of EGTRRA; however, the 2010 Tax Relief Act extended the Bush era tax cuts until the end of 2012, raising the estate, gift, and generation-skipping transfer tax exemption to $5,000,000 ($5,120,000 in 2012 when adjusted for inflation) and lowering the top tax rate to 35 percent. The 2010 Act also established spousal portability, which allowed surviving spouses to “inherit” any exclusion amount not used by the estate of the deceased spouse. Now, as we approach 2013, without Congressional action, these tax cuts are scheduled to expire, and we are facing what has been widely referred to as the “fiscal cliff,” which has the potential to have far-reaching implications for many individuals.
As of January 1, 2013 the $5,000,000 estate tax exemption is reduced to $1,000,000, and the top estate tax rate rises to 55 percent. Taxable estates over $1,000,000 will begin to be taxed at a graduated scale, beginning at 41 percent, with the top tax rate applying to taxable transfers over $3,000,000. An additional five percent surcharge will apply to taxable estates of $10,000,000 to $17,184,000. The gift tax exemption and generation-skipping transfer tax exemption will also be reduced to $1,000,000.
Considering that life insurance proceeds on a policy owned on one’s own life are includable in the gross estate for federal estate tax purposes, under this structure, even modest estates will feel the sting of this new tax structure unless Congress acts to change it. As Congress returns from its pre-election recess, it has only 54 days (less “legislative days” and holiday recesses) in which to come to an agreement. The likelihood that this will be resolved before the end of the year does not look promising.
The recent election results will likely weigh in on what Congress ultimately decides to do. With the re-election of President Obama, if the Congressional majority votes in his favor, the transfer tax structure will likely resemble the parameters of 2009. The estate tax and generation-skipping transfer tax exemption is proposed to be lowered to $3,500,000, with a lifetime gift exemption of $1,000,000. The top estate tax rate of 45 percent would apply to taxable transfers over $1,500,000, and the portable spousal exclusions would be made permanent. What will actually happen is anyone’s guess. What is certain, though, is that if nothing is done to change the potential “fiscal cliff,” estate taxes will rise, and not just for the wealthy.
With all of this uncertainty in sight, there is still time to review your estate plan in light of the changing tax laws, and make sure that the techniques you have in place today still make sense for what may happen in the future.
There is also time to consider taking advantage of the favorable tax laws still in force this year. For example, a married couple may still transfer up to $10,000,000 of assets out of their estate this year, despite the potential decrease in the estate and gift tax exemption in the future. Grantor Retained Annuity Trusts, and their accompanying discount transfer valuations, currently receive favorable tax treatment, but are rumored to potentially be restricted or repealed. Irrevocable life insurance trusts can provide a means of replacing the value of the estate consumed by the estate tax, while sheltering the death benefits from the taxable estate.
No matter what your net worth, it is important to review your estate plan periodically, and make sure it is still applicable to your current circumstances. There may have been births, deaths, marriages or divorces. Somebody else may have come in to your favor whom you wish to remember. You may wish to delete somebody who is currently remembered in your Will. There may be a need to appoint a different executor, guardian or trustee. You may have left an item of property that you no longer own. There may be changes in your own financial circumstances that make a revision of your estate plan desirable.
The impending tax changes in 2013 will certainly impact many people. The “perfect storm” of wealth planning that we have seen for the past two years may be about to end, but there is still time to take advantage of the opportunity to reduce the impact of the Federal Estate Tax.