October 20, 2014

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October 17, 2014

The Effect of the Fiscal Cliff Deal on Estate Planning

In an attempt to avert the "fiscal cliff" at the end of 2012, the American Taxpayer Relief Act of 2012 (the "2012 Act") was passed by Congress on January 1, 2013, and signed into law by the President on January 2, 2013. The 2012 Act has significant impact on all taxpayers, and is a game changing piece of legislation in the estate, gift, and generation-skipping transfer tax area.

The 2012 Act permanently extends the $5,000,000 unified federal estate, gift, and generation skipping transfer (GST) tax exemptions implemented under the 2010 Tax Relief Act for all such transfers occurring after December 31, 2012. All three exemptions are indexed for inflation. As a result, the exemption amounts in 2013 are $5,250,000. The 2012 Act increases the maximum tax rate from thirty-five percent (35%) to forty percent (40%) for any transfers in excess of the exemption amounts.

The 2012 Act also permanently extends portability of unused estate tax exemption for married couples. Portability, a concept introduced in the 2010 Tax Relief Act, allows a surviving spouse to "port" or add a deceased spouse’s unused estate tax exemption amount to the surviving spouse’s exemption amount without the use of a traditional credit shelter trust. However, portability, as noted in our client alert dated December 20, 2010, should not be solely relied on as an estate planning substitute for several reasons. First, the ported amount can be lost if the surviving spouse remarries. Second, portability does not provide the same asset protection after the first spouse’s death that is provided by traditional credit shelter trust planning. Third, portability does not apply to the GST exemption; therefore, to leverage GST planning, careful dynasty trust planning is still necessary.

It should be noted that the exemptions are "permanent" only as long as Congress chooses not to change them (no tax law change should ever be considered "permanent" with a new Congress every two years).

In light of the 2012 Act and the current estate planning environment, estate planning is still necessary, and the following are continuing opportunities for transferring wealth:

Low Interest Rate Planning

Historically low interest rates continue to present the opportunity for intra-family low interest loans or refinancing of low interest intra-family loans. The January 2013 mid-term applicable federal rate (for 3-9 year loans) is 0.87%. Low interest rate loans can also be combined with gifting, resulting in larger tax free transfers. Sales to intentionally defective grantor trusts (IDGTs) and grantor retained annuity trusts (GRATs) are commonly used techniques for this type of planning, and the 2012 Act fortunately did not impose limits on GRATs, IDGTs or valuation discounts that had been proposed earlier. Congress may impose limits on the use of these techniques in the future, but at least for the time being, the window of opportunity for these techniques remains open.

GST Planning

Dynasty trusts that utilize the GST exemption can be used to transfer assets from generation to generation for multiple generations of a family, avoiding estate, gift, and GST tax at each generation. With the high exemptions, a single person can protect $5,250,000 and a married couple can protect $10,500,000, indexed for inflation, in this manner. In addition, as previously noted, GST exemption is not "portable" and therefore, dynasty trusts are important for married couples in protecting the GST exemption of each spouse. Limitations on the number of years a dynasty trust can run were also not part of the 2012 Act.

Asset Protection

Trusts remain an important part of estate planning, even for smaller estates, because they provide means of asset protection. Trusts can be used to protect assets from a beneficiary’s creditors, including a divorcing spouse. Trusts can also protect assets in the event a beneficiary becomes disabled. Lifetime irrevocable trusts also provide an estate and gift tax "freeze" for a donor’s estate at the value of the trust as of the date of the lifetime gift.

Annual Gifts

In addition to the lifetime gift tax exemption, each taxpayer may make annual exclusion gifts to any number of donees. The annual exclusion was indexed for inflation with the 2001 Act, and in 2013 the annual gift tax exclusion amount is $14,000 per donee.

The following are some other notable provisions of the Act that impact individuals:

  • Extends tax cuts for individuals with incomes under $400,000 and married couples under $450,000;
  • Raises the ordinary income tax rate from 35% to 39.6% for individuals with income over $400,000 and married couples with income over $450,000;
  • Raises capital gains and dividend tax from 15% to 20% for individuals with income over $400,000 and married couples with income over $450,000;
  • Overall limit on itemized deductions are reinstated for individuals with income over $250,000 and married couples with income over $300,000, which may impact lifetime charitable giving plans;
  • Permanently indexes the alternative minimum tax (AMT) for inflation;
  • Expands employees’ ability to convert traditional retirement accounts such as 401(k)s and 403(b)s into Roth accounts; and
  • Extends through 2013 the tax free IRA "rollover" to qualifying charities after age 70½ (Note: special rules relate to actions that may be taken in January of 2013 to treat contributions as being made during 2012).
© MICHAEL BEST & FRIEDRICH LLP

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About this Author

Effective taxation work includes both comprehensive planning based on continually changing tax laws and resolution of tax controversies. Michael Best & Friedrich’s taxation team helps clients in these areas and acts as a source of guidance on any tax issue. Our tax attorneys are highly experienced in all aspects of tax law.

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