On January 2, 2013, President Obama signed into law The American Taxpayer Relief Act of 2012 (the “Act”). After many years of provisions with expiration dates, the Act purports to make permanent many aspects of the tax law including the Federal Estate, Gift and Generation Skipping Taxes and income tax rates.
Estate and Gift Taxes
The $5,000,000 unified exemption from estate, gift and generation skipping tax, to be adjusted for inflation, was made permanent. The rate of tax on the excess was increased to 40 percent from 35 percent. The Act also made permanent “portability,” that is, the ability to carry over to a surviving spouse any unused exemption of a decedent. That means in general a husband and wife can pass over $10,000,000 to their heirs free of Federal Estate Tax and they can do so in a way that can avoid any Estate Tax as assets pass down through future generations by the use of generation skipping trusts.
The concept of “permanency” may well be a reaction to the incongruity of a $2,000,000 exemption in 2008, a $3,500,000 exemption in 2009, no estate tax in 2010, the threat of a $1,000,000 exemption in 2011 which was deferred for two years in December 2010 by the enactment of the $5,000,000 exemption (but only for 2011 and 2012 with retention of the threat of the $1,000,000 exemption effective in 2013). Perhaps now the battle to repeal the “death tax” is over with the final result being that this tax will only apply to those families with taxable estates in excess of $10,000,000 as increased to account for inflation after 2011.
There are many provisions of the current law which the Administration considers “loopholes” in need of reform. Congress, in introductory language to the Act, pointed out its desire for tax reform for example by eliminating what it considers unfair tax advantages. So we do not think it appropriate to expect all of the opportunities now available to remain intact. Nevertheless, such actions as making annual gifts of up to now $14,000 per recipient can over time produce very substantial estate tax savings eventually. For that reason and many more, this new law gives us all greater reason for thoughtful and immediate planning.
The first words of the introductory language of the Act were “to extend certain tax relief provisions enacted in 2001 and 2003.” A primary aspect was extending the ordinary income tax rates of 10, 15, 25, 28, 33 and 35 percent and the capital gains and qualified dividend rate of 15 percent for all those with incomes under $450,000 ($400,000 for single taxpayers). The rates for the highest income levels will increase to 39.6 percent for ordinary income and to 20 percent for capital gains and qualified dividends.
However, these rates do not include the new 3.8 percent tax on net investment income (the Unearned Income Medicare Contribution) which became effective in 2013. This tax is payable by those with incomes in excess of $250,000 ($200,000 for single taxpayers) and does apply to capital gains. Further, while the Act made the Alternative Minimum Tax patch permanent, that tax has the effect of increasing the actual tax rate payable by many individuals with substantial deductions and other preference items.
One opportunity included in the Act was allowance of transfer of amounts in qualified retirement plans to Roth accounts. This provision raises revenue for the Government in the short run since income tax is due on the conversion although in the long run it benefits the individual taxpayer and his or her heirs (and costs the Government) since no future income tax is due on Roth accounts no matter how much they may grow.
In general, we know that income taxes will increase in 2013 and very likely beyond. The income tax laws have always favored various methods of building capital, such as qualified retirement plans and IRAs. It also is nice that capital gains rates remain substantially lower than ordinary income tax rates. It is even better not to pay any income tax on accumulations of capital, and that is what happens when assets are not sold. For example, a business that continues to grow and is passed down to future generations can produce income (and livelihoods) for many generations. So can well maintained and continually improved real estate holdings.
The Act did get us past the fiscal cliff at the last minute. What more the Administration and the new Congress may be able to accomplish is yet to be seen. No matter what, we do know that many benefits can be achieved from long term planning and actions to save taxes, to protect assets and to increase the chances that accumulations of wealth will be beneficial (and not detrimental) to the quality of the lives of ourselves and our loved ones.