After almost 12 years of constant changes in the estate tax, ATRA creates certainty on the estate and gift tax. Wealthy households now have the certainty in the regulations that they need to effectively plan their gifts and wills. In 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) allowed a $675,000 effective exclusion. In 2009, the exclusion had escalated to $3.5 million and the maximum statutory rate decreased from 55% to 45%.
In 2010, EGTRRA eliminated the tax. Congress reinstated the taxes for 2011 and 2012. The exemption increased to $5 million and included an inflation index and 35% tax rate.
As part of the temporary settlement to avert the fiscal cliff, the U.S. Senate passed the American Taxpayer Relief Act of 2012 (ATRA) on New Year’s Eve. The next day, the House of Representatives passed the legislation.
Had Congress not reached a decision to avoid spending cuts and massive tax hikes effective January 1, 2013, the exemption would have plummeted to $1 million and without an inflation index. In addition, the top statutory tax rate would have increased to 55%.
ATRA made permanent regulations that had been in effect in 2011 and 2012. Her are the primary elements:
- $5 million exemption per person for bequests and gifts
- Indexed for inflation – $5.25 million in 2013
- Tax rate increase of 40%
Most estates exempted
Only the largest estates must consider ATRA regulations. In fact, 99.9% of estates will not have to pay the tax. The rules allow widows and widowers to use any exemption not claimed by the estate of the deceased spouse. This nullifies the reasoning behind the strategy of shifting the ownership of assets after the spouse dies.
Together, both spouses can transfer $10.5 million tax-free to their beneficiaries in 2013. Make sure that the executor of the estate understands this aspect of tax planning, which is called “portability.” Portability requires some pre-planning such as filing a tax return after the spouse dies—even if no taxes are due.
The permanent rules also improve the probability that heirs of small businesses that have grown in value will not have to sell the enterprises to pay tax obligations.
Past regulations provided incentives in the form of complex credits, which prevented companies from being sold. However, the new owners had to agree to continue operating their businesses for 10 years. Now, heirs have the option of continuing to operate their enterprises or selling and closing out the entities.
The combine $5.25 million per person estate tax exclusion and gift tax in 2013 allows for more precise estate planning strategies. In previous years, lower gift taxes prohibited individuals from transferring assets during their lifetime so that their beneficiaries could enjoy the use of the properties. Many people want to set up trusts or give away property to heirs to benefit from use of the asset.
An individual can transfer assets at a single stage or a combination of the two. If the gifts exceed the limit, you or your heirs will pay up to 40% on the excess amount.
The new rules allow couples to transfer more assets to their kids tax-free. However, keep in mind that when they die it reduces the tax-free amount available. Like any tax deduction, keep a record of these gifts so that the total is available for correctly calculating the estate tax when filing returns.