The American Taxpayer Relief Act of 2012 (the “Act”) was signed into law on Jan. 2, 2013, avoiding dramatic changes to tax exemptions and tax rates on transfers subject to federal estate, gift, and generation-skipping transfer (“GST”) taxation. The Act permanently retains almost all of the 2012 federal transfer tax provisions, benefiting taxpayers by retaining historically high tax exemptions while also providing clarity for 2013 estate planning and beyond. The one notable change from 2012 instituted by the Act with respect to transfer taxation is the increase of federal estate, gift, and GST tax rates from a top rate of 35 percent to 40 percent. The Act does not alter state laws pertaining to transfer taxation.

Significant transfer tax provisions made permanent law as part of the Act

  • $5 million estate, gift, and GST exemption, indexed for inflation, available for each individual taxpayer (a comparison of 2012 and 2013 exemption amounts is presented in Table 1 below)
  • Portability, whereby any gift and estate tax exemption not used by the first spouse to die is available for use by the surviving spouse
  • Estate, gift, and GST top tax rate of 40 percent, increased from 35 percent in 2012

These provisions, other than the portability provision which retroactively applies beginning in 2011, apply to transfers made or occurring after Dec. 31, 2012.

Table 1 – Comparison of Transfer Tax Exemptions and Tax Rates

Click here to see table.

Significant income tax measures made permanent law as part of the Act

The following income tax measures were approved and made permanent law as part of the Act, and may be of interest for estate planning purposes:

  • Top income tax bracket increased from a rate of 35 percent to 39.6 percent on the undistributed net income of estates and trusts
  • Top income tax bracket increased from a rate of 35 percent to 39.6 percent on income exceeding $450,000 for couples and $400,000 for individuals
  • Tax rates on qualified dividends and long-term capital gains adjusted by adding new 15 percent and 20 percent brackets
  • Personal exemptions and itemized deductions phased out for individuals with gross income exceeding $300,000 for couples and $250,000 for individuals
  • Individual alternative minimum tax exemption now indexed for inflation

Charitable distributions from individual retirement plans in 2012 and 2013

Under the Act, plan owners may make certain tax-free distributions from their individual retirement plans for charitable purposes, but distributions may only be made through the end of 2013. Under special transition rules now in place, certain plan distributions paid directly from a plan to charity, or from a plan owner to charity, before Feb. 1, 2013, may be treated as a tax-free distribution made in the year 2012, and not 2013. All distributions paid in 2013 that are not treated as made under the special transition rules are considered paid in the year 2013.

Changes affecting transfer taxation in 2013

In addition to tax changes effective under the Act, the following items are relevant to estate planning in the year 2013.

3.8 percent tax on net investment Income

Beginning Jan. 1, 2013, net investment income is subject to a new 3.8 percent Medicare tax if adjusted gross income exceeds $250,000 for couples and $200,000 for single individuals. This net investment income tax will apply to ordinary investment income, as well as qualified dividends and capital gains, producing a top federal rate (when added to the new highest tax rates effective in 2013) of 43.4 percent with respect to ordinary investment income and 23.8 percent on both qualified dividends and long-term capital gains. Importantly, the 3.8 percent tax also applies to the undistributed net investment income of trusts and estates in excess of the top income tax rate in effect for such entities, currently estimated to be around $12,000 after indexing for inflation.

Exclusion amount increases

The amount a donor may exclude from federal gift taxation for qualifying gifts made to a donee in 2013 has increased as a result of inflation.

Click here to see table.