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Changes in Estate Taxes and Planning

Considering The Tax ShelterOn January 2 of this year, President Obama signed into law the American Taxpayer Relief Act (TRA 2013). In addition to preserving the Bush Administration income tax rates for most people (while raising the highest rate), it also made a handful of significant changes to the federal estate and gift tax provisions. Here’s a summary of those changes.

Estate tax changes ― Without the new law, federal estate taxes were due to revert to an exemption of $1 million ― down from $5.12 million in 2012, and the maximum tax rate was set to increase from 35% to 55%. That would have made for a larger number of estates subject to federal taxes.

Instead, TRA set the exemption at $5.25 million (to be increased by inflation in the future), while raising the maximum estate tax rate to 40%.

Gift tax changes ― TRA 2013 maintains the unity of gift and estate taxes. In other words, the extent to which you make tax-free gifts over your lifetime reduces your estate tax exemption. Otherwise, the new tax law made the same changes in gift taxes as it made in estate taxes. The lifetime limit on tax-free gifts is $5.25 million per donor ($10.5 million for married couples) in 2013, indexed to the annual rate of inflation. The gift tax rate was raised from 35% to 40%.

“Portability” of the estate tax exemption ― TRA 2013 made permanent the “portability” of the estate tax exemption, which President Obama signed into law in 2010 and was scheduled to expire at the end of 2012. Portability refers to the automatic transfer of any portion of the deceased spouse’s estate tax exemption to the surviving spouse, without the use of a credit-shelter trust (also known as an A/B or by-pass trust), subject to the discretion of the executor of the estate.

For example, let’s say a husband dies this your with $6 million in assets. He leaves $4 million to his wife and $2 million to his children. His wife receives her $4 million free of estate taxes, and that amount isn’t counted against the husband’s $5.25 lifetime exemption; only the $2 million he left to his children is. If his executor elects portability, the remaining $3.25 million of the husband’s exemption can be transferred to his surviving spouse’s estate. That means she can pass an estate valued at $9.0 million (the full value of her $5.25 million exemption plus her husband’s unused $3.25 million) to her heirs free of estate taxes without the use of a trust.

Despite portability, in some cases a credit shelter trust may still be beneficial. For example, if there is a long period of time between the death of the husband and that of the surviving spouse, it’s possible that the value of the husband’s assets could grow to an amount that exceeds the combined exemptions. Creating and funding a credit shelter trust with some or all of the husband’s assets would provide greater assurance that the wife could pass on her entire estate with minimal or no federal estate taxes.

It’s a good idea to review your estate plan for any amendments you might need to make in view of these changes. It’s also important to remember that inheritance can trigger additional taxes at the state level and these often change independently of federal changes. What’s more, with the federal government’s fiscal condition as the focus of contentious debates in Washington, it’s possible Congress and the president will make more changes to the tax code this your that could affect estates.

Please call if you’d like to discuss this topic in more detail.

Copyright © Integrated Concepts 2013. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.

Photo Credit: Creative Commons License JD Hancock via Compfight

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