Contributed by Melissa O’Rourke, B.S., M.A., J.D. Farm & Agribusiness Management Specialist, Iowa State University Extension & Outreach, email@example.com
Waiting until the very last moment, Congress passed and the President signed the American Taxpayer Relief Act of 2012 on January 3, 2013. The good news is that a number of key provisions related to federal estate and gift taxes have been made permanent – that is, without an expiration or “sunset” date contained in the current legislation. This brings an increased level of certainty for professional planners and those who have estates that could be impacted by federal estate or gift taxes.
Many farmland owners and farm families have been concerned during the past two years, wondering what would happen to the estate tax exemption under federal law. Essentially, under the federal estate tax law as most recently revised in 2010, individuals can transfer to others a basic exclusionary amount of up to $5 million free of federal taxation during lifetime or at death. This figure is adjusted for inflation, so in 2012 it was $5.12 million. If Congress had failed to act, that tax-free amount would have been automatically reduced to $1 million; and the tax rate for estates over $1 million would have increased to 55%.
Not surprisingly, Congress did not allow this to happen. The new tax law makes the $5 million exemption amount permanent and this exemption will continue to be indexed for inflation. While the exact figures have not been released, the exemption is expected to be $5.25 million for 2013 and up to $7.5 million by 2020.
The only significant change made by Congress is to the tax rate for gift and estate taxes. The formerly top rate of 35% has been increased to a maximum of 40% for estates over the basic exclusionary amount. While this is an increase, it is definitely better than the 55% which would have taken effect if Congress had failed to act – and some observers comment that the 5% increase is a reasonable trade-off for the certainty afforded by the new law.
Two other aspects of the federal estate and gift tax system were also made permanent by the act just passed.
First, provisions allowing portability of the $5 million exemption between spouses remain in effect on a permanent basis. How does this work? In the first instance, the marital deduction remains in place, meaning that spouses can inherit from one another in an unlimited amount (as long as the inheriting spouse is a U.S. citizen). After the first spouse dies, the surviving or second-to-die spouse can add any unused exclusion of the first-to-die spouse to the surviving spouse’s exclusion. In 2013, this will allow spouses to transfer a total of about $10.5 million free of federal estate or gift tax.
It is important that after the death of the first spouse that the unused exclusion amount is transferred to the surviving spouse as part of the estate proceedings – by timely and properly filing of a federal estate tax return, even if no tax is owed. The surviving spouse can use that unused exclusion amount plus their own exclusion to make lifetime gifts or pass assets through the estate of the second-to-die spouse. The surviving spouse should strongly consider filing the estate tax return even if the level of wealth does not appear to reach current exclusion levels since it is difficult to predict increases in estate values during the interim years. As always, families and individuals should seek advice from their personal tax and legal professionals.
Second, the estate and gift tax system will remain “unified.” As noted previously, the $5 million exemption or “unified credit” (with inflation indexing) is applicable to both lifetime gifts and assets passed through an estate after death. Estate planners should document gifts, maintain a cumulative total and report gifts to the IRS so that there is a record of lifetime gifts at the time of death. The total of taxable lifetime gifts is then deducted from the exclusion amount to determine the unused exclusion remaining available at death. Remember, lifetime gifts within the annual exclusion amount ($14,000 in 2013) do not count against the lifetime basic exclusion (the $5 million inflation-adjusted amount). As an example, a couple can give unlimited $28,000 gifts in 2013 to as many different individuals as desired – and these gifts would not count against the lifetime exclusion.
Remember that this article is intended to be an educational, brief summary regarding aspects of the new tax law. All farm families and individuals should obtain advice for their own personal situations from legal and tax professional retained by them for that purpose. As always, please feel free to contact me with your questions and comments.
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