2013 Estate Tax Update
As many of you know, in the opening days of 2013 Congress passed major tax legislation to avoid going over the so-called fiscal cliff. This new legislation includes very important developments relating to estate, gift and generation-skipping transfer taxes.
Federal Estate Tax Exemption Amount
The federal estate tax exemption amount was $5 million in 2011 and $5.12 million in 2012, but was scheduled to drop down to $1 million in 2013 and beyond. The new legislation fixes a “permanent” federal estate tax exemption level of $5 million, with annual increases indexed for inflation. As a result, the 2013 federal estate tax exemption is $5,250,000 and will rise annually in future years based on inflation indexing. As a reminder, this exemption amount is the total amount that an individual can pass (whether by will, trust, joint tenancy, beneficiary designation, etc.) both during life and death without triggering federal estate tax.
Gift and Generation-Skipping Taxes
Gift and generation-skipping transfer (GST) tax exemption amounts are now re-unified with the federal estate tax exemption amount. That is to say that the gift and GST exemption will now match the federal estate tax exemption, along with their annual increases for inflation.
Federal Estate, Gift and GST Exemption Tax Rate
One important change that was made as a compromise was an increase in the tax rate from 35% to 40%. To the extent that an estate (or gift or GST) tax is due, the new single federal estate, gift and GST tax rate is 40%.
Law is now “Permanent”
For the past 12 years, the estate tax law was temporary because it had an automatic built in expiration date set by Congress. The new law is “permanent” in that it will not expire simply due to the failure of Congress to extend the law. Nonetheless, we should all be aware that while tax law is never truly permanent and could be changed at any time by a future Congress, the permanent nature of this law is a welcomed change and will allow for a much greater degree of certainty in our estate planning.
Portability of Deceased Spouse’s Unused Exemption
Prior to 2011, a married individual’s estate tax exemption was a “use it or lose it” proposition. If everything was left to a surviving spouse, the deceased spouse’s estate tax exemption was lost. Beginning in 2011, new rules allowed the transfer of unused exemption to a surviving spouse, but in 2011 these rules were only temporary. Under the new law, the rules allowing the transfer of unused federal exemption to a surviving spouse have now been made permanent, allowing a married couple together to pass twice the single exemption amount. This is a positive development, but married couples must be aware that for a surviving spouse to receive the benefit of portability, the surviving spouse (or the decedent’s executor) must timely file a Federal Estate Tax Return Form 706 making an affirmative election to transfer unused exemption to the surviving spouse. For the return to be timely, the 706 must be filed within 9 months after the death of the first to die (plus an additional 6 months via request for extension). If the 706 is not timely filed, then the unused exemption is lost and cannot later be claimed. As a result, it is now advisable for all estates with surviving spouses to strongly consider preparing and filing the 706 to preserve this additional exemption. In situations where the additional $5+ million exemption is needed for the survivor’s estate, this filing can save the estate more than $2 million (40% of $5+ million). It is important to note that portability does not apply to Illinois Estate Tax Exemption (see below) and does not apply to an individual’s GST exemption.
Also see:Portability: The Tax Election Every Surviving Spouse Must Consider IRS Extends Portability Election Deadline for 2011 to 2013 Estates
Illinois Estate Tax
An individual’s amount exempt from Illinois Estate Tax for 2013 is $4,000,000. This means that estate tax could be due for an Illinois resident (or for a non-resident owning Illinois property) even if a decedent’s estate is too low to be subject to Federal Estate Tax. Under current law, this $4 million amount is fixed – it is not scheduled to increase in future years based on inflation. While the Federal Estate Tax exemption will rise annually, the gap between Illinois and Federal Estate Tax will increase. Consequently, in appropriate situations it is very important to consider the impact of this estate tax gap and to plan accordingly. Those with old estate tax formulas (typically ‘A/B’ trusts created prior to 2006) should consider addressing this issue. Moreover, it is important to note that portability does not apply to Illinois Estate Tax. While a surviving spouse will be able to increase their effective Federal Estate Tax exemption by filing a timely Form 706, this will not increase the Illinois Estate Tax exemption available to a surviving spouse. Planning for the Illinois estate tax would then be appropriate for those with estates exceeding the $4 million threshold. For those with estates exceeding $4 million, a gifting program may be effective in reducing or eliminating Illinois Estate Tax because Illinois does not have a separate gift tax.
Annual Gift Tax Exclusion
Each year an individual may gift up the annual gift tax exclusion amount per beneficiary without triggering any gift tax filing requirements. In 2012, that annual exclusion was $13,000. After indexing for inflation, the new annual exclusion for 2013 is $14,000. This amount is indexed for inflation in $1,000 increments so that it will rise to $15,000 at some point in the future.
For those who were waiting for more estate tax certainty before implementing or amending their estate plan, this new law provides that certainty to put a more clearly defined estate plan into place. The increased exemption will allow many clients to create or adjust an estate plan that focuses on more important non-tax aspects of estate planning, including planning for incapacity, probate and guardianship avoidance, protection for beneficiaries, special needs planning, maximizing retirement benefits and more.