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Estate Tax Update

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The estate planning landscape changes dramatically on January 1, 2013. Currently, the federal estate tax for most of our clients is not a big issue. That is because each person gets a $5.12 million exemption from federal estate tax. Further, there is something called “portability” that allows a surviving spouse to utilize the deceased spouses unused exemption. Basically, this means that a couple with up to $10 million in net worth can completely avoid the federal estate tax. That covers a pretty large swath of the U.S. population. That all goes away on January 1, 2013.

The way things stand now, we will go back to the laws in effect over 10 years ago. The estate exemption will be $1 million per person with no portability. The top estate tax rate will return to 55% up from the current tax rate of 35%. Needless to say, this will recapture a significant number of families that currently don’t have to worry about the estate tax.  This assumes a lame duck Congress does nothing in terms of estate tax legislation. Congress doing nothing seems like a pretty good bet at this point.

Most estate tax commentators do see some reform on the horizon in 2013. Politicians from both parties don’t want to see things go back to the pre-2001 law. Republicans would like to eliminate the estate tax or at least leave the exemption at $5 million, while Democrats want to keep the estate tax with a reduced exemption amount. President Obama supports a $3.5 million exemption and portability. So, it seems likely that there will be some estate tax legislation in 2013, which would be retro-active to the start of the year, but it is hard to guess what the final law might look like.

The question is, should you be doing any proactive planning to prepare for this? The answer, of course, is it depends.

For folks with VERY large estates who have more assets than they are ever likely to spend, a significant year end gift to children, grandchildren or trusts might be worth considering.  There is an opportunity to make a large gift this year, prior to year end. The gift tax exemption for 2013 is $5.12 million. That means an individual could gift $5 million to other family members and there would be no current gift tax due. That’s a significant planning opportunity for someone who can afford to do it. It allows for the assets, and the future growth on those assets, to avoid estate tax. Further, if the assets went into a generation-skipping trust, the assets would escape estate tax at the next generation level as well. Note:  there are complex rules to deal with if you want to “skip a generation”.  Granted, gifting $5 million to children and grandchildren is not something you see every day, but for a certain select group of taxpayers it might be worth considering prior to year end. 

If reducing your estate to avoid future estate tax is a strategy that interests you, then at a minimum you may want to consider making annual gifts. The annual exclusion for 2012 is $13,000 per person.  That means a single person can give $13,000 to anyone and you don’t have to report it to the IRS as a taxable gift.  You can do that to any number of different people.  For example, a single woman with 4 kids and 6 grandchildren could give away $130,000 ($13,000 to each) all gift tax free.  Add another $13,000 on to say three in-laws and you quickly get up to $169,000.   If her husband did the same thing, they could transfer $338,000 out of their estate in one year, without any tax or complex reporting required!  As you can see, just by utilizing the annual gift exclusion you could reduce your gross estate fairly quickly over a couple of years.  The annual gifting exclusion is scheduled to increase to $14,000 for 2013.

NOTE for Ohio residents:  As of January 1, 2013 the Ohio estate tax is eliminated.  Gone.  Zero.  That is a meaningful change.  A client with a $1,000,000 estate would have paid Ohio $45,000 in tax. 

If the federal estate tax exemption does go back down to $1M next year, which seems likely for at least some portion of 2013, you should plan to discuss your situation with your financial advisor and/or your estate planning attorney. It might be prudent to look at how your assets are titled. There may be changes to your estate planning documents that could be appropriate given a much lower exemption. All of that really is up in the air depending on what Congress does with the estate tax.  If you have any further questions about your unique estate and gift tax situation, don’t hesitate to contact your financial advisor at Foster & Motley.