Congress took the fiscal cliff negotiations over the brink but was finally able to reach a deal resulting in the American Taxpayer Relief Act of 2012 (“2012 Act”).  The 2012 Act makes the estate and gift tax laws “permanent,” meaning that they are not scheduled to expire, be repealed or rolled back.  This is a significant change because since the 2001 estate tax legislation was passed under President Bush, taxpayers and their advisors have had to plan based on an uncertain statutory framework.

The 2012 Act sets the estate tax exemption amount at $5 million.  This is the amount of money that can pass estate tax free to any individual without triggering federal estate tax.  In addition, the exemption amount will be adjusted for inflation.  The exemption amount was actually $5.12 million in 2012, and it is predicted that in 2013, the exemption amount will rise to $5.25 million.

The 2012 Act unifies the estate tax with the gift tax.  Thus, the lifetime gift tax exemption amount also equals $5 million (adjusted for inflation).  In addition, the generation-skipping tax (“GST”) exemption amount is set at $5 million (adjusted for inflation).  As a result, a person can gift over $5 million during life ($10 million between spouses) and not trigger any transfer tax.

The maximum estate and gift tax rate was increased from 35% to 40%.

The portability of exemptions between spouses has been permanently extended.  Thus, a surviving spouse will be able to utilize his or her last deceased spouse’s unused exemption amount.  This does require the filing of a federal estate tax return, but with proper elections a surviving spouse can protect up to $10 million (adjusted for inflation) if his or her last deceased spouse did not utilize any of his or her exclusion amounts.

While the exemption amounts are high and portability enables a surviving spouse to use both spouses’ exemptions, there are still many reasons why planning during life is very important, including:

  1. All appreciation on gifted assets escapes federal and state estate taxes.  For this reason, it still may make sense to gift during life for taxpayers who anticipate that their estates will appreciate and/or grow to a level that ultimately exceeds the exemption amounts.
  2. While the federal exemption amount is $5 million, the New Jersey estate tax exemption amount is $675,000 and the New York estate tax exemption amount is $1 million.  A $10 million estate may not be subject to federal estate tax but will be subject to approximately $1 million in New York and New Jersey estate tax.  Proper planning can reduce or eliminate this $1 million state estate tax exposure.
  3. While the estate tax exemption is portable, the state level estate tax exemption and the federal GST exemption are not portable.  If not properly planned for, these valuable exemptions can be wasted, costing significant tax dollars.
  4. The use of sophisticated planning techniques, such as GRATs, sales to grantor trusts, and family limited partnerships were not limited by the 2012 Act.  These techniques may provide additional benefits to taxpayers where lifetime gifting is appropriate.