Ringing in the New Year From the Other Side of the Fiscal Cliff
Trusts & Estates Law Update 01/07/13
As the last minutes ticked off the legislative clock, in the wee hours of the first day of the New Year, Congress passed the American Taxpayer Relief Act of 2012 (the "Act"). Most taxpayers will see an increase in income taxes, and the law does not address the deficit. Payroll taxes resume at customary rates for all taxpayers, and rates rise for those with higher incomes. The good news, however, is this Act does not have a "sunset" provision, so longer term estate planning is once again possible. Here is a look at some of the important changes:
Federal Estate, Gift, and Generation-Skipping Transfer Tax
- The Federal estate, gift and generation skipping transfer tax exemptions were not reduced and will continue to be indexed for inflation. The exemption amount for each tax was $5,120,000 in 2012 and is expected to be $5,250,000 for 2013.
- The maximum tax rate will increase to 40% on estates which exceed the exemption amount. Although this is higher than the 35% rate effective in 2011 and 2012, it is lower than the 45% rate of 2009 and the 55% rate that would have gone into effect without the Act.
- The estate tax exemption will continue to be "portable." This means that if the proper election is made, a surviving spouse will have his or her deceased spouse's unused exemption amount in addition to his or her own exemption amount. This may permit the simplification of existing estate plans for some married persons.
- No change was made to the existing Grantor Retained Annuity Trust rules.
- No change was made to the existing grantor trust rules.
- No change was made to existing law which allows the use of entity-based valuation discounts.
- While not part of the Act, the gift tax annual exclusion amount increases to $14,000 for 2013.
- The Act retains the 10%, 15%, 25%, and 28% income tax brackets permanently.
- It retains the 33% and 35% income tax brackets for taxable incomes up to $400,000 (single), $425,000 (head of household), and $450,000 (joint filers).
- There is a new 39.6% tax rate on taxable income above $400,000 (single), $425,000 (head of household), and $450,000 (joint filers). While the higher top rate is not good news, the higher thresholds are an improvement over the $250,000 joint/$200,000 single modified adjusted gross income thresholds which had been under discussion for months.
- Taxable trusts (non-charitable trusts) with taxable income over $11,950 will see a top tax rate of 39.6% in 2013.
- The phase-out on most itemized deductions is back, and applies to taxpayers with adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers). If this applies, itemized deductions are reduced by 3% of the amount income exceeds the threshold amount. In no case will a taxpayer lose more than 80% of itemized deductions.
- The phase-out of the personal exemption for high income taxpayers returns. This reduces the personal exemption for higher income taxpayers, just as the limitation on itemized deductions operates. However, unlike the itemized deduction limitation, higher income taxpayers can completely lose the benefit of personal exemptions.
- These phase-outs are a "stealth" tax increase for affected taxpayers. However, the Act is not as bad as it could have been, as the phase-outs would have started at much lower adjusted gross income levels in 2013 had the Act not been enacted. This change is probably better for most taxpayers than the cap on itemized deductions proposed by the Administration, and better than the dollar limitation that was offered by Gov. Romney during his campaign.
- A change - which sunsets on December 31, 2013 - is the itemized deduction for state and local sales taxes paid. This deduction had ended after the 2011 tax year, but the Act has restored it for both the 2012 and 2013 tax years. Restoring this deduction is good news for taxpayers who reside in a state without an income tax.
- The maximum long term capital gains tax rate will be 20% for taxpayers with adjusted gross income over $400,000 (single) and $450,000 (joint filers). The tax rate will be 15% for taxpayers below this level of adjusted gross income. This does not include the new 3.8% Medicare surtax imposed on some taxpayers, so the top rate on long term capital gains income of high income taxpayers could be as high as 23.8%. The levels at which the Medicare surtax applies begins at $250,000 for joint filers and $200,000 for single filers. The tax applies to the lesser of a taxpayer's net investment income (taxable interest, dividends, both qualified and nonqualified, rents, royalties, capital gains and income from passive activities) or modified adjusted gross income in excess of these levels.
- The top tax rate on qualified dividends will be 20%, plus the Medicare 3.8% surtax if applicable. Although this is a significant rate increase over 2012, it could have been worse, as the Administration proposal would have taxed dividends at ordinary income tax rates.
- The AMT exemption amount is permanently set at $50,600 for an individual and $78,750 for joint filers. The exemption amount is indexed for inflation from the 2012 levels. This will eliminate the annual "AMT patch" tax bill which has been passed in December each year. Without this provision, millions of taxpayers would have been in for an unanticipated tax increase in 2013.
- There are no changes to the phase-out of the AMT exemption. Taxpayers start to lose the AMT exemption when AMT income exceeds $150,000 for joint filers and $112,500 for single filers, and lose it completely once AMT income reaches $465,000 for joint filers and $314,900 for single filers.
Charitable Contributions from IRAs
- The Act renews the provision allowing charitable contributions from IRA accounts, up to $100,000 per year. This ended in 2011, and of course was not extended until after 2012 was past. However, if a person took a distribution from his or her IRA in December 2012, and if cash gifts are made to charities in January 2013, those can be treated as having been made directly from the IRA to the charities in 2012. Also, a distribution from an IRA account to a charity made in January 2013 may also count as having been made on December 31, 2012. This provision, unlike most of the other changes, sunsets on December 31, 2013.
The 2013 tax rates for individuals and what rates apply to various classes of income is a confusing topic. This table may help:
With respect to the estate, gift and GST tax, the Act is largely positive. Those who made significant gifts in 2012 to take advantage of the $5,120,000 exemption amount have accomplished their estate and gift tax planning objectives. Those who did not make a significant gift in 2012 may still do so, if circumstances allow it, because the favorable lifetime gift tax exemption amount has been extended.
Now that Congress has provided us with some certainty about future estate tax, gift tax, and generation skipping transfer tax rates and exemptions, it might be possible to simplify some estate plans. This may be an ideal time to update your estate plan or to reexamine it to ensure that it disposes of your assets as you wish upon your death.
If you have any questions regarding the new law or your estate plan, please contact your Quarles & Brady attorney, or contact the Quarles & Brady attorney at the office nearest you:
|Chicago||Patrick Bitterman||(312) 715-5122|
|Naples||Brad Rigor||(239) 659-5032|
|Milwaukee||James Daly||(414) 277-5881|
|Phoenix||Trisha Baggs||(602) 229-5381|
|Tampa||Jennifer Griffin||(813) 387-0277|