On January 1, 2013 Congress passed the American Taxpayer Relief Act (the “Act”), which President Obama signed into law on January 2nd in order to avoid the so-called “fiscal cliff.” The Act permanently extended a number of temporary and expiring tax cuts and has significant impact on estate, gift, and generation-skipping transfer (“GST”) tax laws.
FEDERAL ESTATE, GIFT AND GST TAX IN 2013
- The Act makes permanent the federal estate, gift, and GST tax lifetime exemption amount of $5,000,000, indexed for inflation. For 2013, the applicable exemption amount will be $5,250,000. The maximum rate for estate, gift, and GST taxes increased from 35% to 40%, but is below the 55% rate that would have gone into effect had the Act not been signed.
- The federal estate and gift taxes remain “unified,” meaning that any amount of exemption used during a decedent’s lifetime will reduce, dollar-for-dollar, the amount of exemption that is available to such decedent’s estate at death. Similarly, any lifetime use of the GST exemption reduces the amount of exemption available at death.
- The Act also makes permanent the concept of “portability,” which allows a decedent’s surviving spouse to make use of the deceased spouse’s unused exemption. Portability, however, only applies to estate and gift tax exemptions; a deceased spouse’s unused GST tax exemption is not portable. Portability is also a purely federal concept. To date, no state has adopted portability.
- Though not specifically provided for in the Act, the 2013 gift tax annual exclusion increased from $13,000 to $14,000 per donee, or $28,000 if a husband and wife elect to split their gifts in 2013. The gift tax annual exclusion for gifts made to non-citizen spouses increased from $139,000 to $143,000.
- The Act also extends the deduction available to a decedent’s estate for federal estate tax purposes for state estate and inheritance taxes paid.
POSSIBLE FUTURE LEGISLATIVE CHANGES
Grantor Retained Annuity Trusts (GRATs) & Sales to Intentionally Defective Grantor Trusts (IDGTs)
- GRATs and sales to IDGTs are common estate planning techniques used to take advantage of the low interest rate environment. For the month of April, for example, the Section 7520 rate, which is the interest rate used to value annuities or interests for a term of years, is 1.4%. In short, the idea behind a GRAT or a sale to an IDGT is that a donee contributes assets to a trust, and receives, either via a fixed annuity or via annual payments on a promissory note, assets back from the trust over a period of years. To the extent the assets in the GRAT or the IDGT appreciate in excess of the applicable interest rate, that appreciation in value is kept in the trust and passes to the beneficiaries of the trust free of estate or gift taxes. With such low interest rates, it’s easy to see why these are such popular techniques now.
Even though these techniques remain unchanged by the Act, President Obama and certain members of Congress have set forth various proposals to impose restrictions on the use of GRATs and sales to IDGTs.
Discounts for Minority Interests in Closely Held Business Entities
- When valuing minority interests in closely held business entities for estate or gift tax purposes, the donee or estate of the decedent transferring the minority interest is entitled to take a discount on the value of the transferred interest to reflect the lack of marketability or lack of control associated with the minority interest. This allows a donee or decedent to pass more assets on to the intended recipients while simultaneously limiting the use of gift or estate tax exemption.
Again, President Obama and various members of Congress have set forth proposals to limit and, in certain cases, disallow these discounts in the future.
Duration of GST Tax Exemption
- Under existing law, the use of the GST exemption can shelter trusts for the benefit of grandchildren and more remote generations from the GST tax for an indefinite period, indeed in perpetuity in certain jurisdictions.
President Obama has proposed limiting the duration of the GST exemption to 90 years, thereby subjecting any GST trust to GST tax after the expiration of that period.
PLANNING FOR 2013 AND BEYOND
- Review your existing estate plan and determine whether the dispositive provisions are still appropriate given the “permanent” adoption of the new exemptions and rates of tax.
- Consider using your gift tax annual exclusion and also consider use of your remaining gift tax exemption.
- Consider the impact of your state’s estate tax, if any. If you are currently domiciled in a state with an estate or inheritance tax (for example, New York, New Jersey or Connecticut), you may wish to consider making federally taxable gifts to lessen your potential state estate tax liability. This may be an especially attractive option for domiciliaries of states without a separate state gift tax. Connecticut is currently the only state in the country with a separate state gift tax.
- Consider taking advantage of low interest rates by use of a GRAT or a sale to an IDGT before any possible future legislation limits or removes the viability of these options.
- Consider making gifts of fractional interests in closely held business entities to take advantage of discounts for lack of control and lack of marketability.
- Consider GST tax planning.