An Overview of the “Permanent” Estate and Gift Tax Regime

(Last Updated On: January 24, 2017)

On January 1, 2013, Congress passed the 2012 Taxpayer Relief Act (TRA), which President Obama quickly signed into law on January 2.

It blessedly made permanent, meaning at least for the time being, certain provisions of the tax law regarding estate, gift and generation-skipping transfers.

Readers may recall that, for a long period of time, extending from the 1970s through the 1990s, there was a unified gift and estate tax exemption of $600,000, never adjusted for inflation.  Given that the estate tax encompasses practically all of the “wealth” of taxpayers, including homes that have appreciated over the decades, proceeds of life insurance, and account balances in retirement plans, the loved ones of persons who could barely afford to take a vacation found a deceased parent’s estate nevertheless depleted by estate taxes.

As we rolled into the 21st century, we saw substantial increases in the amounts exempt from tax, gradually rising to $2 million and then $3.5 million in 2009.  The capriciousness of a tax that depended upon a person’s date of death was most fully exemplified in 2010 when the estate tax disappeared altogether (exempting the estate of George Steinbrenner from tax) only to be reintroduced in 2011 with a new $5 million exemption.  The TRA will end this estate tax roulette, at least for the foreseeable future.  There are, nevertheless, continuing proposals floating around Congress to, on the one hand, abolish the estate tax altogether and, on the other, significantly reduce exemptions and raise rates.  This article will simply summarize the landscape as it exists now and ostensibly will continue to for some time.

Exemption.  The TRA establishes the estate exemption amount (technically, the “basic exclusion amount”) at $5 million per person as increased by indexing after 2011.  The exemption for 2013 is $5,250,000.

Unified System.  For a few years, the estate tax and the gift tax were decoupled.  They have now been happily reunited, meaning that the exemption applies to lifetime transfers and those at death.  If you give away $3,000,000 in 2013, you still have $2,250,000 to apply against later transfers.  The gift tax annual exclusion ($14,000 this year) remains, as does the exclusion of tuition and medical expense payments from the gift tax base.

Rates.  The maximum estate and gift tax rate was 35% for gifts made and decedents dying in 2012.  The TRA changes the top rate to 40% for gifts made and decedents dying after 2012.

Generation-Skipping Generation Tax.  Without going into the complexities of this, which is an impact on few estates, suffice it to say that 1) the GST tax exemption is equal to the basic exclusion amount of $5 million as indexed; and 2) the GST tax rate is now 40%.

Portability of Unused Exemption Between Spouses.  One of the unfortunate features of the old system was that two families of identical wealth could have dramatically different encounters with the estate tax depending upon whether they had a professionally designed estate plan.  While each spouse might have a separate exemption, the exemption of the first to die would be wasted if everything were left to the surviving spouse, as is typically the case.  Proper planning could ensure that the exemptions of both were used, but this could easily be overlooked.  The 2012 TRA has made permanent a provision allowing the states of decedents to elect to transfer any unused exclusion of the first to die to the surviving spouse.  If the executor of the decedent’s estate elects transfer of the deceased’s unused exclusion, the surviving spouse can apply that amount against any tax liability arising from subsequent lifetime gifts and transfers at death.  This is the feature of “portability” of an unused exemption between spouses.  Use of this feature depends upon filing an estate tax return at the death of the first spouse to die and there are complex rules relating to application of the portability rules upon remarriage, but this does represent a step forward from the old traps for the unwary.

To sum up:

Having a permanent set of estate tax rules means that the shelf-life of an estate plan has suddenly risen from approximately 18 months to a reasonable multiple of years.  Estate planning may now deal with generations rather than months or years.

Second, the Obama administration had sought to limit the utility of certain transfer tax reduction vehicles, such as family limited partnerships or family limited liability companies, but this effort failed.  Persons for whom these transactions make good sense should implement them sooner, rather than later, since measures limiting their applicability are still on the table.

Third, planning for the dispersal of family wealth and the uses of trusts to avoid probate still make planning importance, at least the impact of taxes on such planning has been reduced and made more certain.

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