As Fall approaches, we remain in an era of transfer and income tax uncertainty, where dramatic changes will occur automatically on January 1, 2013 unless Congress acts. We thought it would be a good time to remind clients and other friends of where we stand on a series of potential tax law changes. These tax law changes include the end to the so-called “Bush era tax cuts”, as well as new taxes that were enacted as part of the health care reform legislation.


Until the end of 2012, the federal estate tax and gift tax exclusion amounts are $5,120,000 and the top marginal rate for both taxes is 35%. A single exclusion amount applies to both the federal estate and gift taxes, so any exclusion used for lifetime gifts reduces the estate tax exclusion amount available at death dollar-for-dollar. The generation-skipping transfer (“GST”) tax is a separate tax that applies to transfers to persons two or more generations below the transferor, such as grandchildren. There is a GST exemption amount that also is set at $5,120,000 for 2012 and a flat GST tax of 35%. Absent Congressional action, on January 1, 2013, the federal estate and gift tax exclusion amount will revert to $1,000,000, and the top marginal rates will rise to 55% (plus an additional surtax on certain large estates). The GST exemption amount also will fall to $1,000,000 (plus an inflation adjustment) and the rate will rise to a flat 55%.

The separate estate taxes imposed by many states are not scheduled to change. For example, Massachusetts will continue to shelter only $1,000,000 in property with tax rates up to 16%. Most states, including Massachusetts, do not have a gift tax. However, the current deduction for state death taxes paid will once again return to a dollar-for-dollar credit. This could mitigate the increase in federal rates for states with separate estate taxes. It could also return revenue to states that impose a tax to the extent of the state death tax credit.

While the $5,120,000 gift tax exclusion amount presents a significant opportunity for transfer tax minimization, one must consider many factors in deciding whether to take advantage of the exclusion before its scheduled drop to $1,000,000. There is the obvious question of whether the donor can afford to make a significant gift. There are opportunities for spouses to take advantage of the exclusion in a way that allows them to benefit each other, but these strategies have potential financial ramifications to the couple as well. There also are capital gain and income tax considerations associated with making lifetime gifts. Assets acquired by gift “carry over” the donor’s tax basis while assets inherited at death receive a “step-up” in basis to the date of death value. We are happy to discuss the costs and benefits of the potential options. For clients who have available GST exemption and have previously made gifts, there also may be an opportunity to use some or all of the GST exemption without making a new gift.

The exclusion from the federal estate tax is now “portable” between spouses under certain circumstances. Portability means that any unused exclusion available at a person’s death may be inherited by a surviving spouse and added to the spouse’s own exclusion. Portability does not apply to the GST exemption, and also does not apply to the credits and exemptions available to individuals under most state estate taxes. Spousal portability of unused estate tax exclusion is scheduled to expire in 2013. Because of the limitations on portability, we continue to recommend that married couples not rely on portability but instead design their estate plans to create trusts for the survivor to take advantage of both spouses’ exemptions.


There are many income and capital gains tax changes scheduled to take place on January 1, 2013. Some of the more important ones are summarized below.

Marginal Income Tax Rates

In 2012, the rates used to tax ordinary income run from a lowest marginal rate of 10% to a highest marginal rate of 35%. In 2013, the marginal federal tax rates on ordinary income are scheduled to rise for all taxpayers, with the bottom income tax bracket being taxed at a rate of 15% and the top bracket being taxed at a 39.6% rate.

Dividends and Capital Gains In 2012, both “qualified dividends” and long term capital gains on most assets are taxed at the same 15% rate for federal purposes. In 2013, qualified dividends are scheduled to return to being taxed as ordinary income. This means that qualified dividends will be taxed at marginal rates of up to 39.6% rather than at a flat 15% rate. Long term capital gains are scheduled to be taxed at a maximum rate of 20%. These changes could have an impact on how businesses return value to shareholders and on the structure of client portfolios. Some stocks with high dividend payments may become less attractive to investors. As we approach this potential increase in the capital gains rate, clients may wish to consider locking in the current rates by selling appreciated assets.

Limitations on Itemized Deductions

Along with scheduled rate increases, in 2013 high income taxpayers also may see an effective tax increase in the form of lost itemized deductions. Prior to 2001, the “Pease amendment” reduced certain itemized deductions by 3% of the taxpayer’s adjusted gross income (or “AGI”) in excess of an inflation adjusted amount ($166,800 in 2009, the last year that the Pease amendment was in effect). Up to 80% of the otherwise allowable deductions could be lost. The lost deductions included charitable contributions, mortgage interest, and state and local income and property taxes. Deductions for unreimbursed medical expenses, investment interest, and casualty, theft and wagering losses were immune from the phase-out. These limitations were gradually reduced starting in 2006. In 2010 through 2012, these limitations did not apply at all. These limitations are scheduled to return in full force on January 1, 2013. The loss of the deductions has the effect of increasing the after-tax cost of the taxpayer’s mortgage interest, state and local taxes and charitable contributions. Charitable contributions made before the end of the year will not be subject to the reduction. This favorable consideration must be balanced against the possibility that charitable contributions in the future could shelter income taxed at higher rates. Because the impact of the reduction is directly tied to AGI, the impact for any particular taxpayer will require individual analysis.

Investment Income Taxes and Expanded Medicare Tax.

The recently upheld health care reform legislation expanded the 3.8% Medicare tax to net investment income for certain high income taxpayers effective January 1, 2013. This tax is separate from expiration of the “Bush era tax cuts”. Consequently, any Congressional action on those tax cuts may not impact the scheduled expansion of the Medicare tax.

For an individual taxpayer, the 3.8% tax applies to the taxpayer’s net investment income to the extent that the taxpayer’s AGI exceeds a threshold amount--$200,000 for a single taxpayer or $250,000 for married taxpayers filing jointly. A taxpayer whose AGI is below the applicable threshold amount is not subject to the tax.

“Net investment income” consists of interest, dividends, annuities, royalties and rents; income derived from a passive trade or business; and net gain from disposition of property not used in an active trade or business. Gain on the sale of a principal residence in excess of the applicable exclusions is included in net investment income. Net investment income does not include income from a business on which the taxpayer is already paying self-employment tax (such as income from a partnership or S corporation), income from Social Security, pensions or most retirement accounts, life insurance proceeds or municipal bond interest.

This new investment tax again may cause individuals to rethink their asset allocations and investment strategies. Transactions such as the sale of a home or business would not be subject to the tax if completed this year. The new investment tax also may make gifts of income-producing property to family members more attractive as a way of decreasing the donor’s own AGI and of spreading the income among multiple taxpayers.

The 3.8% tax also applies to a trust’s undistributed net investment income for the tax year to the extent that it exceeds the top income tax bracket for trusts, which is $11,650 in 2012. A trust pays the tax on undistributed income, while the trust’s beneficiaries pay the tax on income that is distributed to them. Trustees will need to take the tax into consideration when income tax planning for trusts. In addition to the tax on investment income, the health care reform legislation also increases Medicare taxes for certain high income individuals. All employees now pay a tax of 1.45% of their wages in order to fund Medicare. (Employers pay an additional 1.45% tax on their employees’ wages.) In 2013, the employee portion of the Medicare tax is increased by an additional 0.9% on wages received in excess of a threshold amount, which again is $200,000 for single taxpayers and $250,000 for married couples filing jointly.

As we approach the November election and the end of 2012, it remains unclear how and when all of these issues will ultimately be resolved. We are pleased to discuss how any of these potential tax law changes may impact your personal planning and what, if any, action should be taken before the end of the year.

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any enclosures) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.