Estate and Gift Tax Provisions of the American Taxpayer Relief Act of 2012

Tax and Estates Alert | January 24, 2013
by: Kevin Koscil

On January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (ATRA) following a drawn-out battle over the impending “fiscal cliff.”  The following day, President Obama signed ATRA into law.  The following is an overview of ATRA’s impact on the gift, estate and generation skipping transfer (GST) tax provisions of the Internal Revenue Code.

ATRA is significant in the federal estate, gift, and GST tax arena for what it prevents; that is, a return to the transfer tax laws as they stood in 2001.  Rather than a return to those 2001 laws, we now have a transfer tax regime that looks very much like it did in 2012.  This is good news because in 2012, taxpayers enjoyed a $5.12 million exemption amount for purposes of the federal estate, gift, and GST taxes.  Essentially, $5.12 million could pass either by gift in 2012 or from the estate of a 2012 decedent free from estate and gift tax.  That number was set to plummet to $1 million in 2013, but now remains above $5 million thanks to ATRA. 

To fully grasp the “changes” effected by ATRA from an estate, gift, and GST tax standpoint, a little background is needed. 

Before enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) , an individual could pass $675,000 (either by gift during life or by transfer at death) free of federal estate and gift tax.  The top tax rate on transfers in excess of the $675,000 exemption amount was 55%.  EGTRRA increased the exemption amount for federal estate tax purposes over the following several years; it reached $2 million in the period extending from 2006 through 2008, $3.5 million in 2009 and, in 2010, the federal estate tax was to be repealed (a virtually unlimited exemption amount).  EGTRRA also set the exemption amount for gift tax purposes at a steady $1 million and periodically reduced the top tax rate on taxable transfers by gift or at death. 

These EGTRRA provisions were to sunset at the end of 2010, at which point, the rates and rules were to revert to those that existed before EGTRRA became law.  This would have represented a significant tax increase vis-à-vis the law which applied in 2010.  The 2010 Tax Relief Act provided temporary relief from the tax increase that would have occurred on account of the EGTRRA sunset.  The 2010 Tax Relief Act gave us a $5 million exemption amount and a 35% top rate for 2011 and a $5.12 million exemption amount with a 35% top rate for 2012.  The exemption amount increased due to an inflation adjustment.  As an unexpected benefit, the exemption and rate applied for gift tax purposes as well.  This allowed large, $5 million, tax-free gifts in 2011 and $5.12 million gifts in 2012. 

The 2010 Tax Relief Act also introduced the concept of “portability,” which allows a decedent’s unused exemption amount to shift to his or her surviving spouse who can use the exemption during life (for gifts) or at death.

The temporary relief brought on by the 2010 Tax Relief Act was set to expire at the end of 2012 at which point the onerous pre-EGTRRA rules and rates would return.  The expiration of EGTRRA and of the 2010 Tax Relief Act would have had dire income tax consequences as well and the impending tax changes were one part of what became popularly known as the “fiscal cliff.”

ATRA represents the compromise tax legislation that largely avoids falling off that “fiscal cliff.”  ATRA permanently establishes the exemption amount at $5 million and indexes that number for inflation.  For 2013, the amount will be $5.25 million, after taking account of the inflation adjustment.  Importantly, the exemption amount continues to apply for both estate and gift tax purposes.  ATRA also sets the top tax rate at 40% for gifts made and decedents dying after 2012.  This is an increase from the 35% rate that prevailed in 2012 but a break from the 55% rate that would have applied in 2013 without legislation.   

With respect to the GST tax, ATRA sets the exemption amount at $5 million (indexed for inflation) and the top rate at 40%.  This is in line with the corresponding estate and gift tax provisions.  ATRA also extends technical modifications to the GST rules made by EGTRRA.

Additionally, ATRA makes permanent the portability provisions enacted as part of the 2010 Tax Relief Act.  This is a significant benefit to taxpayers, though reliance on the portability provisions alone is rarely advisable as a planning strategy.

Lastly, ATRA made permanent a number of other changes enacted as part of EGTRRA, such as the repeal of the State death tax credit in favor of a deduction.  These changes are more technical in nature than the provisions discussed above, but they are important (for example, a return of the State death tax credit would have had significant implications for State death tax purposes) and we are certainly available to discuss them.

It is worth mentioning that many of our clients took advantage of the increased exemption level and made large, tax-free gifts in 2012.  Indeed, across the country, many taxpayers rushed to complete transactions before the door closed on 2012.  Since lifetime gifts are almost always preferred over transfers at death from a tax planning standpoint, those 2012 transfers remain beneficial transactions.  Gifts are tax-efficient because they remove future appreciation from the donor’s estate and generally lead to a lower State death tax bill.   

Those of you who did not take advantage of the opportunity in 2011 and 2012 to make large tax-free gifts have been given a rare opportunity to reconsider.  Those of you who have already transferred $5.12 million under last year’s laws may now transfer even more ($130,000 more) thanks to the inflation adjustment to the exemption amount.  In either case, it is a good time to examine your current estate plan.  ATRA has made many beneficial estate, gift, and GST tax provisions permanent, so the urgency that existed toward the end of 2012 has largely evaporated.  That said, even “permanent” laws can be changed in Washington.  What is here today could be gone tomorrow (or in two months when it comes time to consider the debt ceiling).

As always, the Tax and Estates Practice Group at White and Williams is committed to keeping our clients and friends up to date with important tax developments.  For current information, please refer to the Tax and Estates page on our website, www.whiteandwilliams.com.

IRS Circular 230 Notice: To ensure compliance with certain regulations promulgated by the U.S. Internal Revenue Service, we inform you that any federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding tax-related penalties under the U.S. Internal Revenue Code, or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein, unless expressly stated otherwise.

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation with any specific legal question you may have.