The end of a decade of uncertainty over gift and inheritance taxes


FOR many wealthy people, the American Taxpayer Relief Act, passed by Congress this week, lives up to its name.

For inheritance and gift taxes in particular, all but the richest will likely be able to protect their assets from taxes, now that Congress has finally set the inheritance and gift tax exemptions to $ 5 million (a level that will increase with inflation).

“You could say it eliminates estate tax for 99% of the population, even though I’ve seen numbers going 99.7 or 99.8,” said Richard A. Behrendt, director of estate planning at the Baird financial services company and former Internal Revenue Service inspector. “From a political point of view, the property tax is not there to increase revenue. He is there to control the massive concentration of wealth in a few hands, and he will succeed again. “

And while Congress has also agreed to increase tax rates on dividends and capital gains from 15% to 20% for higher incomes – in addition to the 3.8% Medicare surcharge on these incomes – the rates are still much lower than their ordinary income. For the top earners, whose income comes mainly from their investment portfolios, and not from a salary like most of us, this is a good deal.

Inheritance tax, once an obscure assessment, is evolving and has received a lot of attention since 2001. It was at this point that the person’s exemption from inheritance tax began to increase. progressively from $ 675,000, with a 55% tax for anything over that amount, to $ 3.5 million in 2009 with a 45% tax rate for larger estates. Estate plans have been drafted to take into account foreseeable increases in exemptions.

Then in 2010, contrary to what every accountant and tax lawyer I spoke to at the time thought, the inheritance tax was gone. Congress and President Obama were unable to come to an agreement on the tax. So that year, for the first time since 1916, deceased Americans were not subject to federal inheritance tax. (Their estates always paid state property taxes, where they existed, and other taxes, including capital gains, on the value of transferred assets.)

At the end of 2010, President Obama and House of Commons Speaker John A. Boehner reached an agreement just as unlikely as the expiration of inheritance tax: the new exemption was $ 5 million, indexed to l inflation, with a tax rate of 35%. on any amount greater than that, and it would last two years. Taxes and exemptions for gifts made during someone’s lifetime to children and grandchildren have also been raised to the same level, from $ 1 million and a 55% tax on top.

As I have written several times, this was a much better rate and exemption than expected. He also created a deadline of December 31, 2012, for people who could make a large donation up to or above the exemption level and pay the low donation tax.

The use of the gift exemption was attractive because it meant that these assets would appreciate outside the estate of the person giving the gift. Even paying taxes has become attractive to the very wealthy because of the way inheritance and gift taxes are collected. Take, for example, someone who has exhausted their exemption and wants to give $ 1 million to an heir. The amount it would take to accomplish this differs depending on when it is given. In life, that would cost $ 1.4 million because the 40 percent gift tax is paid as sales tax. If given after death, the estate would have to set aside about $ 1.65 million after deducting 40 percent estate tax. But that presented a conundrum: While it might make perfect sense to give a lot of money over the course of your life and save on inheritance taxes, it does mean ceding control of money, title, or property. actions now. What if you end up needing it? It was not an easy decision, and it led to a rush to the fourth quarter.

As of this week, this is no longer a problem. Inheritance and gift tax exemptions are permanently set at the same level of $ 5 million, indexed to inflation, and the tax rate above this exemption is 40%, compared to 35% . With indexation, the exemption is already around $ 5.25 million per person – double that for a couple – and it will increase at a rate that means most Americans will continue to avoid paying any federal taxes. on estates.

“The new law brings a lot of clarity,” said Dan Kesten, associate lawyer at Davis & Gilbert. “We can better educate our customers and it will be easier for them to make decisions. “

Mr. Kesten added, “For people with less wealth, they may not need a lot of estate planning. I think we are back in the days of simpler wills and the need for lifelong wealth transfers.

Still, there are a few unresolved issues.

REGRETS With the exemption slated to return to $ 1 million with a 55% higher tax rate, many people rushed to take advantage of the maximum gift tax exemption before the end of the year. They can now feel a New Years hangover that could last for a while, especially if they couldn’t really afford to give all they gave.

Mr Behrendt said people who have gone further and set up complicated structures, like trusts that allow spouses to access money or family limited partnerships, might want to cancel them. But they could run up against the IRS

“Can they do it?” He asked. “Not legally. Once you transfer to your children or grandchildren, their property rights are acquired.

John Dadakis, associate attorney at Holland & Knight, said someone could try to argue that the gift was not legitimate and that it was made on the assumption that the ability to do so would go away. But he said a better approach would be to think of those assets now growing up in the estates of your children and grandchildren.

“You are ahead of the game now,” he said.

CURRENT CONCERNS While federal property taxes will no longer affect most of the rich, this group has other concerns.

The most important are the state property taxes. While only Connecticut has a state gift tax, about 20 states have inheritance taxes with much lower exemptions than federal tax. In New Jersey, for example, the exemption is $ 675,000. In New York and Massachusetts, it’s $ 1 million. Above these amounts, tax rates vary from 5 to 16 percent.

Many people can consider retiring in states like Florida that do not have inheritance tax. But as Leiha Macauley, the Boston bureau chief at law firm Day Pitney, pointed out, you can’t always plan when you die.

She said one way to solve this problem was to create trusts that preserve each spouse’s state exemption level. These are the same types of trusts that spouses created to take advantage of the federal exemption before this law made permanent the ability for a spouse to use the exemptions of a deceased spouse. (This is called portability.)

On the plus side for the wealthy, a separate gift exemption known as the annual exclusion has also been indexed to inflation. It is $ 14,000 this year, compared to $ 13,000 last year. It should increase every few years in $ 1,000 increments.

“In a few years it will be $ 30,000 per couple, and you can give that amount to whoever you want,” Macauley said. “We have a couple who give the maximum. They have donated just over $ 2 million over the past few years.

THE FUTURE The very rich could still face inheritance taxes, but there are still sophisticated ways for them to protect the exemption levels multiple times.

Mitchell A. Drossman, national director of wealth planning strategies for US Trust, said two of the big tools that planners feared would be altered but were not annuity trusts kept by the grantor – which allow appreciation of the assets put into the trust to pass on to someone else tax-free – and the ability to discount the shares of a family business because the shares aren’t as liquid as the shares of an open society.

Another concern is that the very rich will become lax in their planning. Carol G. Kroch, general manager of wealth and philanthropic planning at Wilmington Trust, said trusts will always be important to families.

“One of the things people who deal with wealth need to think about is how to manage it,” she said. “A long-term trust is like an endowment for a family. You can still create that reservoir of wealth. You just don’t have that gun on your head.

But as we have seen, the pressure of deadlines is often necessary to get people, including elected officials, to act.


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