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2013 Changes in Estate and Gift Taxes

Posted on January 27, 2013 at 11:05 PM

Now that the fiscal cliff has been averted, there appears to be confusion about the effect on the estate planning. Mostly what Congress did in this arena was to make permanent the system that has been in effect for the past two (2) years. This was an important achievement because, without any action on the government's part, the tax-free amount at federal level would have automatically reverted to $1 million per person, and the Federal estate tax rate for most estates would have increased to 55%. But at the end of the day the only thing the lawmakers actually changed is the Federal gift tax rate and the Federal estate tax rate, which has gone up to a top rate of 40% from a maximum of 35%.

Below we have summarized the most frequently asked questions and answers on the Federal estate and gift taxes after the fiscal cliff deal.

Who has to pay the Federal estate tax

Once you are worth more than a certain amount, taxes shrink your estate.  Under the 2010 tax law, we could each transfer up to $5 million tax-free during life or at death.  That figure is called the basic exclusion amount, and it is adjusted for inflation.  In 2012 it was raised to $5.12 million per person.  The new tax law does not change how much you can pass tax-free.  On January 11, 2013, the IRS announced that, with the inflation adjustment, the Federal estate tax exclusion amount for deaths in 2013 would be $5.25 million.

Do spouses have to pay the Federal estate tax when they inherit from each other

The new law does not change this either.  There is an unlimited marital deduction from the Federal estate and gift taxes that postpones the tax on assets inherited from one spouse to another until the second spouse dies.  This unlimited marital deduction applies only if the inheriting spouse is a U.S. citizen.  Certain tax planning techniquest must be employed for spouses who are non-U.S. citizens.  Contact us for more details. 

How much can my surviving spouse pass tax-free to our heirs

Here is where things get a bit complicated, but in a good way.  The 2010 tax law gave married couples a wonderful tax break, which the new law has made permanent.  Widows and widowers can add any unused estate tax basic exclusion amount of the spouse who died most recently to their own.  This enables them together to transfer up to $10.5 million tax-free.  This is known as portability.  Portability is not automatic.  A personal representative handling the estate of the spouse who died first will need to transfer the unused exclusion to the surviving spouse, who can then use it to make lifetime gifts or pass assets through his or her estate.  The prerequisite is to make an election by filing a Federal estate tax return when the first spouse dies, even if no tax is owed.  This return is due nine (9) months after death of the spouse with a six-month automatic extension allowed.  If a personal representative does not file the return or misses the deadline, the surviving spouse loses the right to portability.  Spouses should file this return even if they are not wealthy today, because no one knows what the future holds. 

To illustrate this, let's assume John dies in 2013 and passes on $3 million to his wife Mary.  He has no taxable estate and his wife, Mary, can pass on up to $7.5 million (her own $5.25 million exclusion plus her husband's unused $2.25 million exclusion) free of federal estate tax.  However, to take advantage of this, Mary must make an "election" on John's federal estate tax return.  This is how the IRS tracks the portability of John's used exclusion.

How does this relate to gifts made during lifetime

The lifetime gift tax exclusion and the estate tax exclusion are expressed as a total amount, currently $5.25 million per person.  It is possible to use this exclusion (sometimes called the “unified credit” to transfer assets at either stage or a combination of the two.  If you exceed the limit, tax of up to 40% will be owed.  The IRS expects you to keep a running tally and report these gifts so it will know how much has already been used up when you pass away.  For example, if you have used $1 million of the exclusion to make taxable lifetime gifts, the unused exclusion if you were to pass away in 2013 would be $4.25 million, rather than $5.25 million.  Under these circumstances, married couples get a break:  they can share the basic exclusion during life (this process is called gift-splitting) and give more to the kids now, tax-free.  But of course this also reduces how much of the tax-free amount will be available when they pass away, either for their own use or to be carried over by the surviving spouse.

Are there lifetime gifts that do not count

Yes, certain lifetime gifts do not count.  We can each give another person up to $14,000 per year without it counting against the lifetime basic exclusion amount.  This amount increased starting in 2013.  This is called the annual gift tax exclusion amount.  Spouses can combine this annual exclusion to double the size of the gift.  This amount should not be confused with the basic exclusion which is $5.25 million referenced above.

For example this year, relying on the annual exclusion, a married couple with a child, who is married and has two (2) children of his or her own, could make a joint cash gift of $28,000 to the adult child, the child’s spouse, and each grandchild – four (4) people – providing the family with $112,000 a year.  Only gifts that exceed the limit count against the lifetime exclusion.  The simplest way to use the annual exclusion is to give cash or other assets each year to each of as many individuals as you wish.  Another possibility is to put money in Section 529 education savings plans for your children.  Establishing these plans for relatives could relieve siblings or children of the need to save for college at a time when they are overwhelmed with current expenses.  It is still important to keep track of your annual gifts.  Contact us or talk to your CPA how to properly report annual gifts.

Should I redo my Will now

Many people do not have at least the basic estate planning documents needed to protect their loved ones.  We highly recommend that you and your spouse (if married) have at least the following basic documents in your estate plans:  a basic Will, Durable Powers of Attorney for financial and health care matters, as well as Health Care Directive and Supplement (also known as a Living Will).  We also highly recommend that you review your estate plan at least once every three (3) years and consult us to determine if any changes may be necessary or not. You should also revisit your estate plan if there have been changes in your personal or financial situation, for example, marriage, dissolution, adoption, acquisition of out-of-state real estate, or other significant events. Contact us today at (206) 915-5085 to discuss your specific situation!

Categories: Wills and Trusts (English)