2013 Brings Estate, Gift & GST Tax "Permanency" At Last

Barbara E. Little of  Schnader writes:  The uncertainty of the last two years was put to rest on January 2, 2013 when President Obama signed into law the "American Taxpayer Relief Act of 2012" (ATRA). The new law saved us from the "Fiscal Cliff" and forestalled significant tax increases for most taxpayers and across-the-board budget cuts. The impact of ATRA is far-reaching and affects all taxpayers (individuals, businesses, estates and trusts) and types of tax (income, capital gains, alternative minimum tax, business, estate, gift and generation-skipping transfer tax). In a series of Alerts, we will explore the full extent of ATRA. This Alert provides a brief summary of ATRA's impact on the gift, estate and generation-skipping transfer tax (GST).

Overview

ATRA makes "permanent" the Bush-era tax provisions with minor modifications. The new tax brackets, rates, exemptions and patches do not sunset and will not change unless Congress enacts new legislation that expressly makes a change.

The following chart highlights the various tax rates under ATRA:

	2012	2013 and Beyond
Maximum Income Tax Rate	35% ($388,350 joint & single)	39.6% ($400,000 single/$450,000 joint/$11,951 trusts1)
Maximum Capital Gain Rate	15% ($35,350 single/$70,700 joint)	20% ($400,000 single/$450,000 joint/$11,951 trusts1)
Medicare Tax on Wages, Self Employment Earnings	Not Applicable	0.9% ($200,000 single/$250,000 joint)
Medicare Tax on Interest, Rents, Royalties, Annuities, Passive Income, Qualified Dividends & Capital Gains	Not Applicable	3.8% ($200,000 single/$250,000 joint)
Payroll Tax	4.2% (earnings up to $110,100)	6.2% (earnings up to $113,700)
Gift Tax	$5.12 million exemption Maximum rate: 35%	$5.25 million1exemption Maximum rate: 40%
Estate Tax	$5.12 million exemption Maximum rate: 35%	$5.25 million1exemption Maximum rate: 40%
GST Tax	$5.12 million exemption Maximum rate: 35%	$5.25 million1exemption Maximum rate: 40%

As of January 1, 2011, the estate, GST and gift tax rate was 35 percent with a unified $5 million exemption. Under ATRA, as of January 1, 2013, the estate, GST and gift tax rate increases from 35 to 40 percent. The unified exemption remains at $5 million (indexed for inflation). In addition, the portability of the exemption to a surviving spouse is preserved under the new law. The exemption amount is indexed for inflation, allowing individuals to acquire additional exemption each year.

Gifting

Annual exclusion gifts are not affected by ATRA. The annual exclusion amount is indexed for inflation, and thus, for 2013, a taxpayer may give up to $14,000 annually to an unlimited number of individuals without using any of the taxpayer's exemption (and without paying any gift tax). Payments made directly to an educational institution for tuition costs or to a medical care provider for medical costs (including medical insurance) are also excluded from gift tax.

There are leveraging benefits to lifetime gifts, as all future appreciation on such gifts will escape gift and estate tax. Also, lifetime gifts benefit from the tax exclusive nature of the gift tax versus the tax inclusive nature of the estate tax. The gift tax is based only on the amount transferred, and the funds used to pay the gift tax are also removed from the taxpayer's estate. If the donor waits until death, the funds used to pay the estate tax will be included in the taxable estate. For individuals who have used the $5.12 million of gift tax exemption that was available in 2012, approximately $130,000 of new gift tax exemption is available in 2013.

In prior discussions, President Obama proposed a minimum 10-year term on Grantor Retained Annuity Trusts (GRATs) and would have prohibited zeroed out GRATs (GRATs designed to incur no gift tax exposure). Those limitations are absent from ATRA. Consequently, short-term zeroed out GRATs are still valuable avenues for transferring wealth, especially with the Section 7520 rate remaining low (only 1 percent for January 2013).

All of these factors continue to make lifetime gifts very attractive for those able to make gifts and retain a comfortable standard of living.

Estate Tax

For 2013, the estate tax rate is 40 percent and the maximum estate tax exemption is $5.25 million (less any exemption used during the decedent's lifetime). The new law did not reinstate the state death tax credit. ATRA continues to allow estates to take a deduction for state death taxes paid. This does not provide a dollar for dollar reduction at the federal level. In fact, for those states imposing an estate tax (e.g., New York and New Jersey), full utilization of the federal estate and GST exemption at the first spouse's death can be expensive. In such states significant state death taxes may be due when the first spouse dies. In states that do not impose a gift tax, the state death tax impact does not apply lifetime gifts - another example of the advantage of lifetime gifts. We encourage all clients to review their wills and other estate planning documents to make sure these documents still reflect their intentions in light of the increased exemption amounts and new portability rules.

Generation-Skipping Transfer (GST)

As of January 1, 2013, the GST tax rate is 40 percent with a GST exemption of $5.25 million. However, portability does not apply to the GST exemption. Therefore, it remains important for married couples to carefully divide their assets in order to maximize use of their individual GST exemptions. Some interest groups were lobbying to limit the duration of a GST Trust to 90 years. This lobbying effort was unsuccessful. GST Trusts may last as long as permitted under state law. (In some states, including Pennsylvania and New Jersey, there is no limitation on the duration of perpetual trusts.)

Portability

An important component of ATRA is that it "permanently" provides for portability of the estate and gift tax exemption (although not for the GST exemption).

This means that married couples can take advantage of a combined "total" of $10.5 million in gift and estate tax exemptions, regardless of the way assets may be titled. Under this new rule, a surviving spouse may use any exemption amount not used by the first spouse to die (plus all prior deceased spouses' unused exemption amounts). The formula for portability is:

$5.25 million exemption of first spouse to die
Less exemption used by first spouse for lifetime gifts
Less exemption used by first spouse for gifts at death
Plus any unused exemption of any prior deceased spouse of the first to die
                                                                                                           

= Unused exemption of first spouse

Plus $5.25 million exemption of surviving spouse
Less exemption already used by surviving spouse for lifetime gifts
                                                                                               

= Balance of exemption available for surviving spouse to use for
   lifetime gifts or gifts at death

For individuals in states that have decoupled from the federal estate tax (e.g., New York and New Jersey), portability may provide more flexibility and planning opportunities to close the gap between a state's exemption amount and the federal exemption amount. Special attention must be given to this option, however, due to portability only applying to the estate exemption, not the GST exemption.

Concluding Reflection

Assuming Congress does not undo these "permanent" taxes, ATRA provides opportunities to engage in long-term planning that reflects personal goals and values while maximizing the benefits of the current exemption and tax rate.

Footnote

1. The inflation index for 2013 has not been confirmed; therefore, this amount is approximate

Tax And Estate Planning Effects Of The American Taxpayer Relief Act Of 2012

Today global legal services firm Mayer-Brown writes:  The American Taxpayer Relief Act of 2012 (the Act) became effective on January 2, 2013. The Act contains a number of notable changes to the federal estate, gift, generation-skipping transfer (GST) and income tax laws, which are summarized in this Legal Update.

Estate, Gift and GST Tax Changes

Rates and Exemption Amount. Prior to the enactment of the Act, the estate, gift and GST tax rates were scheduled to increase from 35 percent to 55 percent in 2013. At the same time, the estate and gift tax exemption was scheduled to decrease from $5.12 million to $1 million and the GST tax exemption was scheduled to decrease from $5.12 million to approximately $1.39 million. However, the Act prevented these changes by providing new rates and exemption amounts for the estate, gift and GST taxes.

The Act purports to permanently unify the estate and gift taxes, meaning that the same rate and exemption amount will apply to the estate tax and the gift tax. The Act increases the estate and gift tax rate from 35 percent to 40 percent and sets the GST tax rate at a flat 40 percent. In addition, the Act makes permanent the $5 million estate, gift and GST tax exemption that has been in effect since 2011. This amount is adjusted for inflation after 2011, resulting in $5.25 million estate, gift and GST tax exemptions for 2013.

Portability. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 included a provision that allowed a surviving spouse to use a deceased spouse's unused estate tax exemption, referred to as "portability." The Act makes permanent this portability provision, which otherwise would have expired on December 31, 2012. Thus, a married couple has a combined federal estate and gift tax exemption of $10.5 million in 2013.

However, there is currently no portability at the state estate tax level. Accordingly, estate plans should be carefully structured so as to take advantage of federal estate and gift tax portability to the maximum extent possible, while minimizing state estate tax liability. In addition, the GST tax exemption is still not portable, so careful planning is necessary for taxpayers who wish to minimize future estate taxes by setting up GST or "dynasty" trusts for their descendants.

Annual Gift Tax Exclusion. As in prior years, the annual gift tax exclusion continues to be indexed for inflation. The annual gift tax exclusion amount increased from $13,000 per gift recipient for 2012 to $14,000 per gift recipient for 2013.

Income Tax Changes

Rates for Individuals. The Act makes permanent the 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent marginal income tax rates for: ï," Married taxpayers filing jointly with taxable income of $450,000 or less.

• Heads of household with taxable income of $425,000 or less.
• Unmarried taxpayers with taxable income of $400,000 or less.
• Married taxpayers filing separately with taxable income of $225,000 or less.

In addition, the Act creates a new top tax bracket with a marginal tax rate of 39.6 percent, which applies to taxpayers whose taxable income is higher than those listed above.

Rates for Trusts and Estates. The Act makes permanent the 15 percent, 25 percent, 28 percent and 33 percent marginal income tax rates for trusts and estates, while adding a new top 39.6 percent tax bracket, which applies after the first $11,950 of income. Income earned by "grantor trusts" will continue to be taxed to the grantor at the grantor's individual income tax rate.

Capital Gains and Dividends. For most taxpayers, the tax rate for capital gains and dividends remains 15 percent. However, the Act raises the top tax rate for capital gains and dividends to 20 percent for those taxpayers in the new 39.6 percent tax bracket. It should be noted that the Affordable Care Act (also known as "Obama Care") imposes an additional 3.8 percent tax on investment income, which effectively increases the capital gains and dividends rates from 15 percent and 20 percent to 18.8 percent and 23.8 percent, respectively.

S corporation shareholders should give careful consideration to whether this additional tax will apply to investment income received from the S corporation. Specifically, the 3.8 percent tax will apply to pass-through income earned by S corporation shareholders who do not actively participate in the business. On the other hand, pass-through income earned by S corporation shareholders who do actively participate in the business will not be subject to the additional tax imposed by the Affordable Care Act.

Alternative Minimum Tax. Following years of temporary patches, the Act permanently fixes the Alternative Minimum Tax by increasing the 2012 exemption amount and indexing the exemption amount for inflation in 2013 and beyond.

Reinstatement of Limit on Itemized

Deductions. The Act reinstates the "Pease" limitation on itemized deductions. The Pease limitation, which has not been in effect since 2010, applies when a taxpayer's adjusted gross income exceeds the following specified amounts, which are indexed for inflation:

• $300,000 for married taxpayers filing jointly.
• $275,000 for heads of household.
• $250,000 for unmarried taxpayers.
• $150,000 for married taxpayers filing separately.

The Pease limitation reduces a taxpayer's itemized deductions by the lesser of 3 percent of the amount by which the taxpayer's AGI exceeds the specified amount or 80 percent of the amount of itemized deductions the taxpayer would otherwise be allowed to take.

Reinstatement of Personal Exemption

Phase-out. The Act also reinstates the personal exemption phase-out (the PEP), which reduces the amount of personal exemptions allowable for certain higher income taxpayers. The PEP applies to taxpayers whose AGI exceeds certain threshold amounts. The threshold amounts at which the PEP will apply are the same as those amounts listed above for the Pease limitation. Under the PEP, a taxpayer's allowable personal exemptions are reduced by 2 percent for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeds the threshold amount.

Charitable Gifts From Retirement Plans

The Act reinstates a tax provision allowing taxpayers over age 70 1/2 to make up to $100,000 per year of tax-free charitable distributions from an IRA. Although this provision expired at the end of 2011, the Act provides that transfers from an IRA to charity made in January 2013 will be treated as having been made in 2012. Any transfers to charity made after February 1, 2013 will be treated as having been made in 2013. This provision has not been made permanent and is set to expire at the end of 2013. In addition, the Act provides taxpayers with a limited opportunity to take advantage retroactively of the IRA charitable rollover in 2012. Specifically, a taxpayer who received a distribution from his or her IRA between December 1, 2012, and December 31, 2012, may make a direct qualifying gift of a portion of that distribution to a qualifying charity until January 31, 2013. Subject to certain technical requirements, the charitable gift made by the taxpayer will be treated as if it had been made directly from the IRA to the charity.

Applicable Federal Rates for February 2013 Released by IRS

Various prescribed rates for federal income tax purposes for February 2013 have been provided by the IRS. The annual short-term, mid-term, and long-term applicable federal interest rates (AFRs) are 0.21 percent, 1.01 percent and 2.52 percent, respectively. The semiannual short-term, mid-term, and long-term AFRs are 0.21 percent, 1.01 percent and 2.50 percent, respectively. Quarterly short-term, mid-term and long-term AFRs are 0.21 percent, 1.01 percent and 2.49 percent, respectively. Finally, the monthly short-term, mid-term and long-term rates are 0.21 percent, 1.01 percent and 2.49 percent, respectively.

The short-term, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for February 2013 for purposes of Code Sec. 1288(b) are 0.29 percent, 1.15 percent, and 2.77 percent, respectively, when annual compounding is used.  Additionally, the Code Sec. 382 adjusted federal long-term rate is 2.77 percent, and the long-term tax-exempt rate is 2.83 percent. The Code Sec. 42(b)(2) appropriate percentage for the 70-percent present-value, low-income housing credit is 7.40 percent, and the appropriate percentage for the 30-percent present-value, low-income housing credit is 3.17 percent. Finally, theCode Sec. 7520 AFR for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest is 1.20 percent.

THREE CAPITAL GAINS TAX PLANNING STRATEGIES

Jon T. Meyer, CFP® at BGM Wealth Management offers 3 capital gains tax planning strategies, let's take a look.  Jon writes: Retirement planning is both a little simpler and a little harder as a result of the fiscal cliff legislation. The American Taxpayer Relief Act (ATRA) of 2012 has changed the way many people should think about retirement income strategy. On one hand, things are simpler because the bill makes many of the new rules permanent. On the other hand, things got a little harder because there are so many vagaries that can trip you up. The capital gains/dividend tax is a good example.

Capital Gains and Dividend Taxes: The Basics

The ATRA changed tax rates on capital gains based on income level. For those with over $450,000 of taxable income (not modified adjusted gross income; taxable income is after your deductions) the new capital gains rate is 20%. For those with incomes under $450,000, the old 0% and 15% capital gains rates were made permanent. For many, 0% sounds like a funny number, but for couples with 2013 taxable income under $72,500 ($36,250 for individuals), the 0% rate applies.  The ATRA also changed qualified dividend income to follow capital gains rates. Thus, qualified dividends are taxed at 15% up to $450,000 in taxable income, and then at 20% after that. 

But Wait, There's More: The New Medicare Tax

Now, consider the extra Medicare tax in the Affordable Care Act. Starting in 2013, there is an extra3.8% Medicare tax on net investment income (which includes capital gains and dividends) for couples whose modified adjusted gross income (MAGI) is over $250,000 ($200,000 for individuals). With this new tax, the real capital gains tax for couples is 18.8% (15% plus 3.8%) if their MAGI is over $250,000 and 23.8% if their taxable income jumps to $450,000. Note the difference between "MAGI" and "taxable income" since this will trip many people up.

Tax Planning Thought #1

From a retirement income standpoint, the fact that we still have the 0% and 15% tax brackets on capital gains is great news. In retirement, many people can keep their income down by delaying Social Security benefits or other income. In those years, selling assets that have a gain so that the gains fill up the 0% bracket (as noted above, up to $72,500 of taxable income for couples in 2013) can be a big win. Even if you go above that, the 15% rate is better than most of us expected.

Tax Planning Thought #2

For couples with MAGI over $250,000 ($200,000 for individuals), the new 3.8% Medicare tax on net investment income means some people will pay a higher tax on capital gains (effectively 18.8%). Since the extra 3.8% is based off MAGI and not taxable income, itemized deductions (like charitable gifts, property taxes, etc.) will not help you reduce your income and avoid the tax. But if you are at this income level there is an opportunity to gift IRA assets to charity (assuming you are over age 70½) instead of taking the required minimum distribution (RMD) and having that included in your MAGI.

Tax Planning Thought #3

For couples with taxable income over $450,000 ($400,000 for individuals) there really is no 20% rate, since it jumps directly to 23.8% (20% capital gains rate plus 3.8% Medicare tax). But at this level, due to a phase out of itemized deductions and personal exemptions, the real tax is slightly higher. For these individuals in particular, tax deferral through 401(k) contributions has a bigger impact. In taxable accounts (like standard brokerage accounts), low turnover investments (like passive investing) will help.

Annual Planning More Important Than Ever

The interplay of regular income and capital gains/dividend income is going to make annual planning even more important, especially if you can control when you take certain income, like IRA distributions or capital gains. Take the time talking to your financial advisor and accountant now so that you are not surprised later.

Tax Planning Ideas for 2013

Elaine E. Bedel, CFP® @ Bedel Financial Consulting, Inc. offers some Tax Planning Ideas for 2013.  She writes:  Recent legislation has increased the tax that many investors will pay on their investment earnings.  In order to reduce the impact, the earlier you implement certain strategies, the better.  The new taxes on investment income will reduce the benefit you have received in the past for investing in individual stocks and bonds, mutual funds, and real estate, as well as the interest you have been paid on the personal loans made to others.  There are several strategies that you can consider to lower the impact of the new tax provisions. However, to accomplish these strategies, it will be necessary to start early. 

New Investment Taxes

There are two tax laws that have increased the tax you will pay on your net investment income in 2013.  Investment income, also referred to as “unearned” income, includes interest, dividends, long- and short-term capital gains, rents, annuities, royalties, and any income from passive activities.

      The Patient Protection and Affordability Care Act (PPACA) of 2010 included a new 3.8% Medicare contribution tax that will be imposed on investment income beginning this year.  This is in addition to the ordinary income or capital gains tax that investment income is already subject to.  This additional tax of 3.8% will apply to single filers with adjusted gross income of $200,000 ($250,000 for joint filers).

·     Tax on investment income was further impacted by the American Taxpayer Relief Act (ATRA) passed on January 1^st that increased the long-term capital gain tax rate from 15% to 20% for single taxpayers with taxable income of $400,000 ($450,000 for joint filers).

Tax Reducing Strategies

1.   Investment Income Not Subject to New Tax:  If appropriate for your overall planning, you can consider investing in areas that are exempt from the new Medicare contribution tax.

·    Tax-exempt Income:  Tax-exempt income is not subject to the new 3.8% tax.  You earn tax-exempt income by investing in municipal bonds that are issued by a state, city, or other municipality.

·     IRA and Qualified Plan Distributions:  Any distribution taken from an IRA, 401k, 403b, or other qualified retirement plan is specifically exempt from the new 3.8% tax. This means that no portion of your retirement income will be subject to any investment tax.

2.       Manage Capital Gain: Since capital gain will be subject to the higher rate of 20% for some investors as well as the additional 3.8%, managing the creation of capital gain while still meeting your personal investment objectives will require careful planning. The strategies below should be considered where appropriate.

·         Installment Sale.  If you anticipate selling property, consider an installment sale that will spread the realized capital gain over the purchase period.  You pay tax on the capital gain in the year that you receive sale proceeds.  This may allow you to maintain an income level under the thresholds that trigger the higher 20% capital gains tax as well as the new 3.8% additional tax.  However, this strategy may not be appropriate if the total amount of the sale proceeds is needed immediately or if there is a concern regarding the credit worthiness of the buyer.

·         Property Swap.  A section 1031 real estate transaction allows you to trade your property for another. Any capital gain in your original property is transferred to the newly acquired property, allowing you to defer any capital gains tax until the newly acquired property is sold, perhaps when your overall income is below the thresholds.  This type of a transaction is not appropriate if you desire to receive cash versus owning other property.

·         Gift Appreciated Assets. 

o    To Charity: You do not pay capital gains tax on appreciated property, such as shares of individual stock, mutual fund units, artwork, or real estate, that is donated to a charity. Therefore, if you plan to gift cash to your favorite charity, it would be more beneficial to gift appreciated assets instead.  You receive a charitable tax deduction based on the fair market value and you avoid paying any tax on the asset’s capital gain.

o    To Family: If you gift an appreciated asset to other family members or others, the new owner will maintain your cost basis.  This means that the new owner will pay the capital gain based on what you originally paid for the asset. This strategy would be appropriate if the new owner has less income and may not be subject to the 3.8% additional tax or the higher 20% capital gains tax.

·         Permanently Avoid Capital Gain.  Any property that is inherited gets a “step up” in cost basis for the new owner. This means when the new owner sells the property, the cost basis is equal to the fair market value when inherited. By passing appreciated assets to others through your estate, any capital gain in the property is totally and permanently avoided.

·         Offset Capital Gains with Capital Losses.  Prior to year-end, review your portfolio and if you have realized any gains from selling investments during the year, consider selling investments that are trading at a loss.  The loss offsets the gain and avoids the capital gain tax as well as the 3.8% additional tax.

·         Charitable Remainder Trust (CRT).  CRTs provide income to the donor for a period of time and the proceeds to a charity at the end of the period. You can contribute appreciated assets to a CRT; sell the assets within the CRT; and avoid paying the capital gains tax. The income distributed to the donor is taxable, but will be spread over a specific period or the life of the donor.  A charitable deduction is also received by the donor in the year the CRT is funded. If you have a desire to benefit a charity while continuing to receive income, this vehicle should be considered.   

3.       Reduce Taxable Income:  The higher capital gains tax and the additional investment income tax of 3.8% are only applicable if your income exceeds certain thresholds.  Therefore, if you can reduce the income that is subject to tax, you may be able to remain under the thresholds.

·         Maximize Retirement Plan Contributions. By maximizing pre-tax contributions to an employer retirement plan (401k, 403b), a self-employed plan (Keogh, SEP, Solo 401k), or a deductible IRA, you will reduce your taxable income.  Lowering your taxable income may allow you to remain under the thresholds, so that your investment earnings from non-retirement portfolios may avoid the additional investment tax.  

·         Gift Income Producing Property.  If income is not needed and the value of the property is not necessary for your future financial security, you may consider gifting income producing property to other family members whose income is below the thresholds.

·         IRA Charitable Distribution.  If you are over 70 ½ years of age, you are eligible to distribute up to $100,000 to a charity. Since a qualified charitable IRA distribution can be counted as all or a portion of your required minimum distribution, by using your IRA for any charitable contributions, you are reducing your taxable income. 

·         Tax Advantaged Investments.  Another way to reduce income is through investments that provide non-cash tax deductions, such as depreciation. For example, the depreciation claimed on a rental house will first reduce any income from the rental property, and then other passive income.