Estate Planning Law Changes

Early this year, Congress passed the 2012 American Taxpayer Relief Act (the "2012 Act") in response to the "fiscal cliff." Among other items, the 2012 Act addressed the expiration of certain favorable federal estate, gift, and generation-skipping transfer ("GST") tax rules. The purpose of this article is to provide a summary of the new estate, gift, and GST tax rules and explain how those rules could be significant for your estate plan.   

Beginning in 2001, taxpayers and estate planners experienced a great deal of uncertainty relating to tax laws and estate planning. With the 2001 enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), the estate and GST tax exemptions were set to increase slowly from 2001 through 2009 up to a maximum exemption of $3.5 million, followed by a complete repeal of the estate and GST taxes in 2010. EGTRRA also cut estate and GST tax rates for estates in the top tax bracket from 55% to 45% over the same period. While EGTRRA did not increase the gift tax exemption for this period, it did reduce gift tax rates. After 2010, the favorable rates and exemption amounts for federal estate, gift, and GST taxes were set to return to their pre-2001 levels. 

Late in 2010, shortly before rates and exemption amounts reverted to their pre-2001 levels, Congress enacted the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act ("TRA"). The TRA provided a $5 million estate tax exemption (adjusted annually for inflation) and cut the top estate tax rate to 35%. The TRA also unified the federal estate, gift, and GST tax exemptions so that the lifetime gift and GST exemptions were $5 million each, and the top tax rate for each was 35%. Lastly, the TRA allowed for portability in estate administration. Portability means that a surviving spouse can use a deceased spouse’s unused exemption amount. With portability, the estate tax exemption of one spouse can effectively be transferred to the surviving spouse without any additional estate planning. While the rules under TRA continued to be favorable towards taxpayers, they were only effective for tax years 2011 and 2012. Unless Congress acted, tax rates and exemption amounts would return to their pre-2001 levels beginning January 1, 2013. 

The 2012 Act prevented this steep increase in estate, gift and GST taxes that was scheduled to take effect at the beginning of this year. Under the 2012 Act, the estate, gift, and GST exemption for 2013 is $5,250,000, and this exemption amount will increase with inflation. In addition, the Act set estate, gift, and GST tax rates at 40%. Lastly, the Act provided for continued portability among spouses. Unlike under EGTRRA and TRA, the favorable provisions of the 2012 Act are not set to expire. The result of these "permanent" tax changes included in the 2012 Act is that there is more certainty in tax and estate planning than there has been at any time in the last decade. 

Another result of these tax changes is that previous tax planning strategies may no longer be appropriate for certain taxpayers. When lower exemption amounts applied, it was common practice to divide a person’s estate into two portions. One portion passed to the surviving spouse, and other portion passed to non-spouse beneficiaries, typically under a trust. Under this type of a plan, the portion set aside for non-spouse beneficiaries was typically calculated to equal the lesser of the estate tax exemption in effect at the time of the death or the full amount of the estate. When the exemption was only $650,000 or $1 million, this type of a plan often still left a substantial portion of the estate to the surviving spouse. Now that the exemptions have increased to over $5 million, however, this type of a calculation will often result in the full estate passing to the trust rather than the surviving spouse. This may not be consistent with your plans, and it may also not be sufficient to provide for your spouse in the event of your death.   

With the increased certainty that these favorable tax laws will not automatically change in the future, and the possibility that your current estate plan may no longer fit your needs, it may be a good time to review your estate plan and discuss whether it remains appropriate for you.  As always, we remind clients that it is a good idea to review your estate plan at least once every five years and also whenever there has been a change in your circumstances or in the tax laws. If you would like more details about any of information described in this letter, or if you are interested in a review of your estate plan, you should feel free to contact any member of the BrownWinick estate planning group.