Does it ever seem to you like Congress is spinning its wheels on a road to nowhere? 2013 is looming ahead and once again we are left wondering what Congress will do about transfer taxes, such as estate and gift taxes. Unfortunately, no one has a map for where Congress is headed with respect to these taxes. Certainly, the last few years have brought significant changes to the tax code. One thing remains certain – there are sure to be more changes to come.
Taxpayers likely feel déjà vu all over. Once again, major tax cuts are set to expire at the end of the year, as was the case in 2010. Now, like then, Washington legislators are faced with a choice; let income, capital-gains, estate and other tax rates rise as scheduled or work together to develop an alternative. While lawmakers in 2010 devised a two-year “band aid” for the tax cut expiration, it took until mid-December of that year for them to hammer out a deal. Unfortunately, the year 2012 is shaping up to be even worse. Lawmakers are faced with numerous roadblocks – a presidential election, talk of a major tax overhaul and, not surprisingly, lingering partisan bitterness over other political issues. So, what should people do to protect themselves and their families in the wake of this uncertainty? People should plan for the worst and hope for the best.
The current tax laws offer taxpayers a $5 million gift and estate tax exemption for 2012, with a 35% tax rate. This means that every U.S. resident can transfer up to $5 million of their own personal wealth during their lifetime and/or at death without being subject to transfer tax. Even better, any transfers in excess of the exemption amount are taxed at a rate of only 35% (which is equal to the highest income tax rate). This is a significant change from the Economic Growth and Tax Relief Reconciliation Act (EGTRRA). Under EGTRRA, the individual exemption amount and tax rate varied depending on the year of death and size of the estate. The exemption amount under EGTRRA was slated to “sunset” and return to $1 million in 2011, with a tax rate of 55% applied to the estate and/or gift (in excess of the exemption amount). While Congress acted to increase the exemption amount (to $5 million) and decrease the tax rate (to 35%), they only agreed to a two year revision of the tax laws. These laws are set to expire on December 31st of this year. Here we go…again.
In 2013, absent Congressional action, a $1 million1 estate, gift, and GST exemption and 55% tax rate will once again become the law of the land. If, however, the $5 million exclusion were to remain very few Americans would ever have to consider the federal estate tax. In this case, the vast majority of people could and should focus on non-tax aspects of estate planning. They could address state estate taxes2, income tax considerations, probate avoidance and creditor/divorce protection for their beneficiaries. Alternatively, high-net worth individuals should consider utilizing aggressive estate planning techniques and view 2012 as the last window of opportunity to protect their legacy from unnecessary taxation.
If the $5 million exemption is eliminated and the $1 million exemption reinstated with the 55% tax rate, many more Americans would get caught by the costly estate tax. Granted, the current economic climate has reduced or completely eliminated the growth in many individual's estates. Nevertheless, many Americans do and/or will have a taxable estate of $1 million at the times of their deaths. It is important to consider that the fair market value of everything from real property to home furnishings to investment accounts and life insurance proceeds are used to calculate the value of an individual's estate for estate tax purposes. Thus, a significant number of people should consider the potential that a future estate tax will apply to them if the $1 million exemption returns. Again, high-net worth taxpayers should consider using aggressive tax planning techniques for the same reasons highlighted above.
Some people may be loath to incur the cost and unpleasantness of sophisticated tax planning. These taxpayers would be prudent, however, to evaluate less costly and simpler techniques that will at least carry them through this period of uncertainty. Certainly, it is advisable for everyone to evaluate the current laws and the possible changes to determine what impact they have on their estates and not wait for adverse tax news in a few years. As a starting point, everyone should consider revising estate plans to address the full range of potential tax potholes. Only one thing is certain – tax laws will change. People should consider this uncertainty as the new “normal” and remember that flexibility is key. Estate planning documents should be nimble to account for future, and perhaps unforeseeable, changes. Otherwise, navigating the complex roads of estate and tax planning will be left to your loved ones at a time they are least prepared to deal with it.