By: Morris Law Group - March 13, 2013
On January 2, 2013, President Obama signed the American Taxpayer Relief Act of 2012 (the "ATR Act") which provided clarity to estate tax planning by making permanent the $5,000,000 gift, estate, and GST tax exemption amounts which were temporarily in place during 2011 and 2012. Prior to the enactment of the ATR Act, the exemption amount was scheduled to be reduced to $1,000,000 with a 55% tax rate on January 1, 2013.
The extended $5,000,000 figure is inflation adjusted; in 2012, the inflation-adjusted amount was $5,120,000 per person ($10,240,000 for married couples) and in 2013 is approximately $5,250,000 per person ($10,500,000 for married couples). The available annual exclusion is also inflation adjusted and has been increased from $13,000 ($26,000 for married couples) in 2012 to $14,000 ($28,000 for married couples) in 2013. This "annual exclusion" amount is the amount which can be given to any donee per year without the use of any portion of the donor's remaining gift tax exemption.
The ATR Act provides for a new 40 percent rate for any transfers during 2013 and future years which exceed the remaining gift and estate tax exemption. This new 40 percent rate is less than the previously scheduled tax rate of 55 percent, but has been increased from the 35 percent rate of 2010, 2011 and 2012.
The ATR Act has also made permanent certain provisions introduced by the Economic Growth and Tax Relief Reconciliation ATR Act of 2001, including the deduction for state death taxes under Code Section 2058, provisions related to the extension of time to pay estate tax under Code Section 6166 and certain generation skipping transfer ("GST") tax provisions, such as the automatic allocation of GST tax exemption to indirect skips.
"Portability" has also been made permanent. Portability allows the unused estate tax exemption amount of the first spouse to die to be passed to the surviving spouse for later use (either during the surviving spouse's life or at their death). To illustrate, assume the first spouse to die passes with assets valued at $3,000,000 in 2013, that spouse will pass his or her unused estate tax exemption amount ($2,250,000) to the surviving spouse who will then have a total of $7,500,000 ($5,250,000 plus the unused exemption of $2,250,000) of gift and estate tax exemption which can be utilized during life or at the time of their death.
The ATR Act also extends, for a limited time, the prior charitable rollover treatment existing during the years of 2010 and 2011. The ATR Act provides for tax free distributions to eligible charities from an Individual Retirement Account ("IRA") held by someone age 70 Â½ or older of up to $100,000 per year. Additionally, the ATR Act provides that individuals who took their 2012 required minimum distribution ("RMD") in December of 2012 can use such RMD to make charitable contributions of up to $100,000 prior to February 1, 2013 and will be treated as making the contribution in 2012, providing an offset for the 2012 income from the RMD.
What was not changed by the ATR Act? Restrictive legislation has been proposed to curtail certain tax planning strategies and instruments, such as mandating a minimum term in the use of grantor retained annuity trusts ("GRATs"), placing restrictions on the ability to take valuation discounts on certain transfers and limiting the use of both defective grantor trusts and generation skipping tax exempt dynasty trusts. It was thought that these restrictions may have been contained within the ATR Act, but they were not included in such legislation. However, taxpayers should be aware that it is still possible for these mandates and limitations to be addressed in future legislation.
Prior to the ATR Act being passed, in 2011 and 2012, taxpayers had the ability to gift $5,000,000 and $5,120,000, respectively, without being subject to taxation. Many taxpayers were concerned that, with the exemption scheduled to be reduced to $1,000,000 on January 1, 2013, they could either use or lose their temporarily increased exemption. To address the potential for the scheduled reduced exemption, many individuals made significant gifts prior to 2013 to fully utilize their remaining exemption amount. Such gifts were made in various ways, including outright gifts of assets, gifts in trust or forgiving previously given loans. With hindsight, some individuals would have preferred to retain such assets given that they could now make the same amount of gifts in 2013 and future years. However, there are significant advantages from both creditor protection and tax minimization perspectives to making gifts rather than retaining the funds, especially if such gifts were made to defective grantor trusts.
To illustrate the relative benefits of making gifts rather than retaining funds, assume a married couple made a $10,240,000 gift during 2012 to an intentionally defective grantor trust for the benefit of their descendants. If they were in a car accident during 2013 or later and were sued for negligence, a resulting judgment generally could not be satisfied by the funds gifted during 2012; such gifted assets would be protected for their descendants. Additionally, if they made a bad investment in real estate and had to default on personal guarantees related to the investment, the lender generally could not seek to attach the funds gifted during 2012; such gifted assets would again be protected for their descendants.
There are also benefits to making the gifts from a tax minimization perspective. Making the gift during 2012 rather than retaining the funds would allow for any future appreciation on the assets to escape estate taxation; assuming a rate of return on the gifted assets of 5%, the assets in the trust would be worth $10,752,000 by the end of 2013. This is an additional $512,000 of assets that are now sheltered after just one year. At a 40% tax rate, this is a savings of $204,800. If the return on the assets increased, the relative benefits would be even greater. Additionally, the grantors will be able to pay the income taxes attributable to the $512,000 from personal funds, which is essentially a tax-free gift to the trusts' ultimate beneficiaries. Note that any time during 2013, the couple could make an additional gift of $260,000 (an additional $130,000 each due to the inflation adjustment) to the trust without incurring additional gift taxes.
The ATR Act's permanent extension of the gift, estate, and GST tax exemption amounts provides welcomed clarity to taxpayers who wish to engage in estate planning. We are able to help you develop a tax-saving and wealth preservation strategy designed to fit your particular needs; please contact our office for further information.
New Reporting Requirement for Foreign Financial Assets
United States taxpayers are now required to report foreign financial assets owned as of March 18, 2010 on IRS Form 8938. Additionally, resident aliens are required to report if they are permanent residents (green card holders) or meet the substantial presence test; non-residents who elect to be treated as resident aliens are also required to report, even if they do not otherwise meet the substantial presence test or green card test.
This form must be filed with the Form 1040 tax return; however, filing an extension for the 1040 also extends the time to file Form 8938.
** Disclaimer Required by IRS Circular 230** Unless otherwise expressly approved in advance by the undersigned, any discussion of federal tax matters herein is not intended and cannot be used 1) to avoid penalties under the Federal tax laws, or 2) to promote, market or recommend to another party any transaction or tax-related matter addressed.