The status of estate planning

Whether or not one believes America’s economy was teetering on a fiscal cliff, those of us in the estate planning counselor business were happy to see Congress provide some certainty by passing the American Taxpayer Relief Act of 2012 (“ATRA”), which allows us to better advise our clients. 

The last-minute action to pass the ATRA by the Senate on New Year’s Eve, and by the House a day later, now makes permanent the system that has been in effect for the past two years.   Absent ATRA, the amount a person could pass on to a party who is not their heir would have automatically reverted to $1 million per person, and the rate for most estates would have gone up to 55 percent.    In this author’s opinion, the estate tax would have unfairly burdened far too many middle class individuals, as well as closely-held family businesses or farms.

The upshot of ATRA is that a person can transfer up to $5 million to another person who is not his or her spouse, tax-free during life or at death. That figure is called the basic exclusion amount, and it is adjusted for inflation. In 2012 it was raised to $5.12 million per person.  On Jan. 11, the IRS announced that, with the inflation adjustment, the estate tax exclusion amount for deaths in 2013 would be $5.25 million.

Please note, spouses do not pay estate taxes when they inherit from each other.  The marital deduction applies only if the inheriting spouse is a U.S. citizen.

Further, since 2010,  the law had included a tax break for couples sometimes called portability.  Widows and widowers may add any unused exclusion of the spouse who died most recently to their own. This enables them together to transfer up to $10.24 million tax-free.   The recently passed ATRA makes portability permanent.

However, it is critical to note that portability is not automatic. The personal representative (a/ka  executor) handling the estate of the spouse who died will need to transfer the unused exclusion to the survivor, who can then use it to make lifetime gifts or pass assets through his or her estate. The prerequisite is filing an estate tax return when the first spouse dies, even if no tax is owed.   This return is due nine months after death with a six-month extension allowed. If the executor doesn’t file the return or misses the deadline, the spouse loses the right to portability. Thus, it is advisable for a spouse to file such a return even if their assets do not approach $10 million at the time of their spouse’s death, since assets can row. 

Additionally, it is important to understand the interplay of lifetime gifting and after death bequests.  The lifetime gift tax exclusion and the estate tax exclusion are expressed as a combined amount.  This means that a party can use the $5.25 million per person exclusion to transfer assets during life, after death or in combination.   The IRS expects individuals to keep a running tally and report lifetime gifts so that the IRS will know how much has already been used up when you die.

Example:   Mom, aged 78, a widow, passes after having made $2 million of lifetime gifts to her children, and reported same.  Her unused exclusion in 2013 will be $3.25 million, rather than $5.25 million.  If her taxable estate is $11.25 million, and she never filed a tax return to preserve portability, she will pay estate taxes on $6M ($11.25M less $5.25M). 

Under ATRA, each individual is allowed to gift $14,000 per year to another person without it counting against the lifetime exemption.  Further, spouses can combine this annual exclusion to double the size of the gift. Don’t confuse it with the basic exclusion (as discussed above, $5.25 million). 

But of course this also reduces how much of the tax-free amount will be available when they die, either for their own use or to be carried over by the survivor.

Example:   A married couple with a child who is married and has two children could make a joint cash gift of $28,000 to the adult child, the child’s spouse and each grandchild providing the family with $112,000 a year (4 people times $28,000.00).   Only gifts that exceed the limit count against the lifetime exclusion.

The simplest way for individuals who have reached that enviable point of life when their assets are more than adequate for their own use and retirement is to use the annual exclusion is to give cash or other assets each year to each of as many individuals as you want.   Some individuals choose to gift money to Section 529 education savings plans.

Based on the enactment of ATRA, a common question will be whether individuals will want to revisit their will or other estate planning documents.  The answer is that it depends.  If you have created an estate plan in the last three to five years, and your assets as a couple, including all life insurance are less than five million, you may not find it necessary, especially if there have not been significant changes to your assets or decisions for choice of fiduciaries.   As always, if you have a question, you may consult your estate planning attorney.