There have been questions raised regarding how to plan an estate with the new law enacted as a part of the American Taxpayer Relief Act of 2012 (ATRA). There has been a lot of coverage on the income tax aspects of the new law, but not much has been written on the estate tax aspects.
Federal Exemption Amount
The estate provisions in ATRA are as good as or even better than we could have anticipated. First, the law was made permanent (or as good as permanent is possible in Washington.) There will be no more getting to the end of the year and not knowing what the law will be the next year. We now have a $5 million federal exemption amount that is indexed for inflation. It is $5.25 million for deaths in 2013. However, Congress did increase the top tax rate from 35% to 40%, but that only applies after you exceed the exemption amount. Remember, for a married couple, each person has the $5.25 million exemption so the couple can have a $10.5 million estate without being subject to federal estate tax if both die in 2013.
The provision allowing unlimited gifts to a spouse has been retained. Consequently, if one spouse has a federal estate of $8 million and the other of $2 million, the spouse with the higher estate could transfer property valued at $3 million to the other spouse. This would leave both with a $5 million estate. However, a genuine transfer is required.
The new law retains the portability feature. This means that if the first to die has an estate of less than $5.25 million, the unused exemption amount can be transferred to the surviving spouse. Assume Harry and Sally, husband and wife, have estates of $3 million and $4 million respectively. If Harry dies in 2013, he will only use $3 million of his federal exemption leaving $2.25 million unused. Assuming Harry's executor files a federal estate tax return, they can elect to pass the unused $2.25 million exemption to Sally, who now has a $6.25 million exemption available at her death.
While it might not seem important to make the portability election in small estates, you never know what can happen in the future. Maybe the surviving spouse will inherit property or win the lottery and have a huge estate at death. Adding the deceased spouse's unused exemption could save thousands of dollars of estate tax.
Another part of the new law makes the unification of the gift tax and the federal exemption amount permanent. In 2012, taxpayers could make gifts totaling $5.12 million during their lifetime, but the federal exemption amount was reduced by the same amount at death. Before the new law was passed, there was concern that if the federal exemption amount dropped back to $1 million, the IRS could "claw-back" the gift to $1 million. This is no longer a concern. Gifting makes economic sense because all future appreciation of the gifted asset is with the Donee and is not in the Donor's estate.