Editor’s Note: This is Part 2 of a 3-Part series. Click here for Part 1.
By Merry H. Balson and Laurie A. Hunter
How does the 2012 Tax Act affect estate planning?
Lifetime Gifts. Many clients who were concerned that sunset would cause the estate tax exemption to decrease from $5 million to $1 million made gifts before the end of 2012 to use all or part of the $5 million exemption. Those who did not make end of year gifts in 2012 (and those who did but did not fully use their exemption equivalent) are given another chance to make such gifts because the historically high exemptions are still in effect. Completed irrevocable gifts can remove future appreciation from the donors’ estates, as well as give trust beneficiaries other benefits of irrevocable trusts generally, such as creditor protection and protection from claims of divorcing spouses (in certain circumstances). In addition, if only one spouse made a gift to an irrevocable trust for the benefit of the other spouse, but because of the “reciprocal trust rule” the other spouse did not make a similar gift, that spouse may now wish to consider, after the passage of time, making a gift of their own.
Keep in mind that the downside of making gifts still applies: no stepped up basis on death. Instead, the gifted assets have a “carryover basis” from the donor.
Continued Use of Family or Credit Shelter Trusts. There are a number of reasons an estate planner should continue to discuss the use of family trusts or credit shelter trusts in estate plans instead of relying solely on portability of the first spouse’s unused exemption. First, future appreciation of assets in the family trust will pass estate tax free. Second, income from the family trust can accumulate outside the surviving spouse’s estate. Third, the family trust can be designed to provide creditor protection for the surviving spouse. Fourth, assets in the family trust can avoid claims of a new spouse to the trust assets either at the surviving spouse’s death or divorce. Finally, the family trust can provide a vehicle for an independent trustee to administer the assets, especially in the case of a blended family.
Addressing Portability Election in Planning Documents. With the permanence of portability, practitioners who are not already doing so should consider the extent to which the portability election should be addressed in wills and trusts. The documents could require the personal representative to elect portability on a timely filed estate tax return or could merely authorize the personal representative to do so. Additionally, consider addressing who should bear the cost of the estate return preparation, particularly where the return is being filed solely to elect portability. Furthermore, issues relating to the portability election may also be a subject for negotiation in premarital or postmaritial agreements.
Income Tax Changes in the 2012 Tax Act. In addition to the estate and gift tax provisions, there are numerous income tax provisions in the 2012 Tax Act. The following is a summary of some of those provisions affecting individuals:
- Tax rates stay the same for most taxpayers. Individuals will have an increased tax rate (back to Clinton-era rates) if they have taxable income over $400,000, and married filing jointly taxable income is over $450,000. The top tax rate will be 39.6%.
- Payroll tax rate returns to 2010 level. The 2% reduction in the social security payroll tax has expired. Withholding will increase for all taxpayers back to the 2010 level.
- Long-Term Capital Gains rates stay at 0% (for 10% and 15% rate taxpayers) and 15% (for up to 35% rate taxpayers). For those in the new 39.6% rate, the capital gain rate will be 20%. Qualified dividend rates stay at the same rates as long-term capital gains.
- Alternative Minimum Tax changes are made “permanent” so that the income levels are $50,600 for single taxpayers and $78,750 for married filing jointly, and these levels are indexed for inflation. Previously, these changes had to be adopted every year.
- Personal exemptions will be reduced because the suspended phaseout is again in effect. For $250,000 single taxpayers or for $300,000 for married filing jointly, the personal exemption will be reduced by 2% for each $2,500 over the threshold. These levels will be adjusted for inflation.
- The limits on itemized deductions that had been suspended will again apply so that for the same threshold for the personal exemption levels discussed above, the total amount of itemized deductions will be reduced by 3% of the amount by which the taxpayer’s income exceeds the threshold, but not more than 80%.
- Trusts and Estates reach the highest tax rate (now 39.6%) at roughly $12,000 in taxable income, so trusts in particular may be subject to the higher income tax rate, the higher capital gains rate and the new 3.8% surtax on investment income mentioned below.
To be continued…
 Rev. Proc. 2013-15, Sec. 1.01, 2013-5 IRS 444 (January 11, 2013).
 Pub.L. 112-240, Sec. 101 (a-b), H.R. 8, 126 Stat. 2313 (2013).
 Pub.L. 112-240, Sec. 102(b), H.R. 8, 126 Stat. 2313 (2013).
 Pub.L. 112-240, Sec. 102(a), H.R. 8, 126 Stat. 2313 (2013).
 Pub.L. 112-240, Sec. 104, H.R. 8, 126 Stat. 2313 (2013).
 Pub.L. 112-240, Sec. 101(b), H.R. 8, 126 Stat. 2313 (2013).