If Congress doesn't act in a lame-duck session, on Jan. 1, the current $5.12 million per-person exclusion from the federal estate and gift tax will automatically dip to $1 million and the tax on transfers above that amount will rise from 35% to up to 55%. Will it come to that? Perhaps temporarily, but the estate tax exemption has never gone down, and even President Obama favors a $3.5 million exemption. So while there’s a chance the exemption will fall to the $3.5 million level, more likely it will stay where it is (with any decline to $1 million fixed retroactively).
Expect Congress to also extend the special tax break for married couples that’s scheduled to go poof at the dawn of 2013. Portability, as tax geeks call it, allows widows and widowers to add any unused estate tax exclusion of the spouse who died most recently to their own. That means, depending on which exemption amount prevails, married couples together will be able to transfer a total of $7 million, or $10.24 million, tax-free.
What’s more at risk is the ability of people worth more than that to pare down their estates with lifetime gifts. The past two years have been a bonanza for them, since they had the option of shifting up to $5 million worth of assets. With cute tax tricks, a lot more than that could be transferred. Congress could well let the lifetime gift tax exemption fall back to $1 million.
From an estate planning perspective, lifetime gifts have always had an advantage over passing assets when you die. Such gifts leave less in your estate for the government to tax, and if the assets increase in value after you have passed them along, you will not owe gift tax on the appreciation. So for the super rich, a drastic drop in the tax-free amount is a huge loss.
Most of us will never come close to using this exemption, however. One reason is that without incurring gift tax or eating into the lifetime exemption, you can give up to $13,000 each year to as many recipients as you like. Couples can combine this annual exclusion to jointly give $26,000. For example, this year a married couple with a child who is married and has two children could make a joint cash gift of $26,000 to the adult child, the child’s spouse and each grandchild – four people – providing the family with $104,000 a year. Starting in 2013, the annual exclusion for gifts goes up to $14,000 ($28,000 per couple).
If you’re rich enough–and generous enough–to care about the lifetime exemption, get ready not only for the limit to drop, but also for Congress to whittle away at most of the tax tricks that “leverage,” or pack even more into, the tax-free amount. This is not likely to happen during the lame-duck Congress, or even as part of comprehensive estate planning legislation. Rather, it will probably surface as Congress looks to raise revenue to offset specific expenditures.
So watch out for those transportation funding bills, where sneaky lawmakers in the past came close to nullifying a long-time favorite–the grantor retained annuity trust or GRAT, which involves putting appreciating assets into a short-term irrevocable trust (two years is typical) and retaining the right to receive an annual income stream for the term of the trust.
President Obama’s proposed budget for 2013, issued last February, gives us a clear idea of what he would like to do. And it’s not a pretty picture for rich folks or the wealth management industry. The Green Book, as it is called, downloads here as a pdf.
Article originally published on Forbes by Deborah L. Jacobs
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