This December, for the third time in four years, Americans will be faced with a significant change to the federal tax laws that may significantly affect their estate planning. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 will expire on December 31st of this year and barring Congressional Action, 2013 will begin with significant changes to the tax rates and exemptions that many have relied on in preparing their estate plans.
This potential change, which has been termed “Taxmageddon” by many in the media, could be prevented if Congress and the President agree on a temporary or permanent change to the Tax Code. However, with a national election coming in November and less than two months after that for any action to occur, there is a very real possibility that the below changes will go into effect.
Here is how these changes will affect your estate plan if there is no action by Congress and the President:
Estate and Generation Skipping Transfer Tax (GST Tax) Exemptions and Rates-The 2010 Tax Act increased the federal estate and GST tax exemption to the highest amount it has ever been and reduced the top tax rate to the lowest it has ever been. After an adjustment at the end of 2011, the exemption stands at $5.12 million and the top tax rate is 35%. Without a change to the law, starting in 2013, the exemption drops to $1 million and the top tax rate increases to 55%.
Gift Tax Lifetime Exemption and Rates-Currently, the lifetime gift tax exemption and top gift tax rate mirror the estate tax exemptions and rates. However, prior to the end of 2011, the gift tax exemption had remained much lower than the increasing estate tax exemption. And while opponent of the estate tax will likely work diligently to return the exemption to as close to the current exemption as possible, it is unclear that the gift tax exemption will have the same current support. With a drop from $5.12 million to $1 million, the ability to make large lifetime gifts may soon disappear forever.
Portability of Spouse’s Estate Tax Exemption-One of the new ideas enacted by the 2010 Tax Act was the concept of portability. Previously, a spouse could utilize their deceased spouse’s estate tax exemption only by using a credit-shelter trust created under their will. The 2010 Tax Act allowed spouses to utilize any unused part of their spouse’s estate tax exemption without using a trust. This concept will sunset along with the other provisions of the 2010 Act and it is unclear whether it will be continued when and if the Tax Code is amended.
Personal Income Tax Rates-All federal income tax rates are set to increase in 2013 with the largest increases falling on those making less than $9,000 a year and those making more than $380,000 a year. It is uniformly agreed amongst both political parties than increasing the tax rates of most Americans would be harmful to our already fragile economy. The difference that exists is about whether or not the tax rates for the top income earners should remain at the current 35% level or increase to 39.6%. There is also some support for an additional tax on persons making over $1 million a year in income.
Personal Capital Gains Tax Rates-The current 15% tax rate for long-term capital gains will expire at the end of 2012 and increase to 20% beginning in 2013. In addition, all dividends will be subject to ordinary income tax rates as the distinction between qualified and ordinary dividends will disappear. For high earners, an additional 3.8% surcharge on capital gains income will be applied as part of the Affordable Care Act.
These changes can significantly alter not only a person’s financial planning, but their estate planning as well. With less than six months until this change comes and the two political parties in no position to compromise, now is the time to speak with your financial advisors and your estate planning attorney to understand the consequences of this possible ‘doomsday’ scenario.
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