The conventional wisdom among the attorneys and CPAs who plan for estate taxes, right up until the new Fiscal Cliff legislation was signed into law, was that the $5 million exemption was probably too good to be true. Couples could gift up to $10 million to their heirs without paying any gift taxes, and if you died with less than $5 million in your estate, your spouse could pick up the remainder and add it to his/her exemption, meaning that any family with less than $10 million in assets passing on to heirs could, with virtually no planning, escape federal estate taxes altogether.
A deal like that won’t last in this age of budget deficits, right? During calendar 2012, the assumption was that Congress would set a lower exemption of anywhere from $1 million to $3 million per individual. So, estate planning professionals were busy drafting irrevocable grantor trusts and advising their clients to put millions of dollars out of reach of the anticipated new estate tax realities.
Then something unexpected happened: when it passed the American Taxpayer Relief Act of 2012, Congress not only made the $5 million exemption permanent, it also indexed those historically-high exemption amounts to inflation, so that this year the personal estate tax exemption climbs to $5.12 million. And contrary to virtually every professional expectation, Congress also kept the gift tax exemption at the same level as the estate exemption–and made THAT permanent. Many were speculating over the past couple of years that the linkage between the gift tax and estate tax exemption had been a careless mistake by the committee members who had drafted prior legislation.
The result? Assuming these thresholds stay permanent, the overwhelming majority of American citizens won’t have to face a federal estate tax ever again. They won’t have to consult with an expert to concoct a lot of fancy strategies, like putting their investment assets in an LLC and then gifting shares of the LLC at a “minority interest valuation discount,” or buying permanent life insurance inside a carefully-crafted insurance trust, or creating a grantor trust that is defective under IRS rules so that the grantors also pay the taxes on those assets on behalf of their heirs.
Meanwhile, a lot of trusts that were set up in the last two years are probably unnecessary under the new tax regime. The new 39.6% top tax rates affect taxpayers with more than $400,000 (individual) or $450,000 (joint) in income. But that highest rate kicks in at just $11,950 in non-distributed income for a trust. A trust’s capital gains are hit almost immediately at the highest possible rate–20% plus the 3.8% Medicare tax. This is true even if the beneficiaries are in a much lower tax bracket.
One of the consequences of the legislation is the sudden impact all this is having on the 16 states which currently impose their own estate taxes. Suppose, for example, a person with $4 million in assets lives in New York, which has a state estate tax exemption of $1 million. After that, the state taxes the deceased’s assets at a 16% rate. But currently there is nothing to prevent this person from gifting $3.1 million to her heirs on her deathbed, thereby taking her state-taxable estate below the threshold.
For many people, these permanent higher thresholds are great news, and will greatly simplify their lives. Millions of dollars will no longer have to be spent on trusts and creative strategies, streamlining the economy and planning opportunities
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