How The American Taxpayer Relief Act of 2012 May Effect You
On January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 ("ATRA") in an effort to stave off increased taxes that were required to take place at the beginning of 2013 under previously enacted laws. Below is a brief overview of the major issues dealt with in ATRA for your consideration along with other estate planning strategies.
Unified Estate and Gift Tax Exclusions
Federal Estate Tax Exclusion
The Estate Tax Exclusion amount will remain at $5.120 million, with adjustments for inflation, as set forth in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 and extended in ATRA. In 2012, the inflation adjustment resulted in an Exclusion Amount of $5.120 million. Therefore there is no federal estate tax on estates that amount to less than $5.120 million.
Lifetime Gift Exclusion
The Lifetime Gift Exclusion is tied to the Estate Tax Exclusion of $5.120 million, with adjustments for inflation. The estate of an individual who made a gift of $2 million during his or her life time (and filed the required gift tax return), will not be taxed on that amount.
Generation-Skipping Transfer Tax
The Generation-Skipping Transfer Tax (where a decedent has skipped a generation in making a gift to a family member, such as giving a portion or all of his estate directly to the grandchild or grandchildren and "skipping" his child or children) the exemption also is tied to the tax on estates and lifetime gifts; and thus has also been made permanent at $5.120 million, to be adjusted for inflation.
Tax Rate Above the Exempt Amount
The Federal Estate Tax is the tax on the amount of an individual's or married couple's estate that is in excess of the exclusion amount. Under ATRA, the Federal Estate Tax rate has increased from 35% to 40%. This means that for all estates in excess of the exclusion amount referenced above, an estate over that limit will now be taxed at a rate of 40%.
Annual Gift Tax Exclusion
The Annual Gift Tax Exclusion amount increased from $13,000 to $14,000 under ATRA. This law provides that an individual may make annual gifts to an unlimited number of persons in an amount of up to $14,000 per year tax-free. Tax on these annual gifts will thus be avoided as long as a gift of no more than $14,000 is made from one individual to any other individual in one calendar year. For example, if a married couple has two children, and four grandchildren, the husband and wife have the right to each give $14,000 to each child and/or grandchild, tax-free.
The "Marital Deduction" refers to marital assets that pass from one spouse to the other spouse tax-free following the death of the first spouse. For all United States citizens, the amount that can pass from one spouse to the other at death is unlimited. This tax law remains unchanged under the new legislation.
Highest Marginal Income Tax Rate
The previous tax brackets of 10%, 15%, 25%, 28% and 33% are permanently extended through ATRA. The existing 35% bracket is limited to a minimum of $400,000 in income at or for single filers. ATRA provides for a new 39.6% bracket, which will apply to those with income in excess of the following amounts:
Married Filing Jointly: $450,000 of taxable income
Qualifying Widow(er): $450,000 of taxable income
Head of Household: $425,000 of taxable income
Single: $400,000 of taxable income
Married Filing Separately:$225,000 of taxable income
The charitable deduction rate is linked to an individual or married couple's highest tax rate. For example, if an individual or married couple's earnings are taxed at the rate of 33% , the deduction value of a charitable donation for that family is equal to the same rate of 33%. The deduction, however, has been capped at 35%, even for families who are taxed at the higher rate of 39.6%.
As a result of the new legislation, individuals with income in excess of $250,000 and married couples with income in excess of $300,000, will see a reduction of 3% on the value of itemized deductions.
Tax on Dividends and Capital Gains
The tax on capital gains and qualified dividends will now increase from 15% to 20% for gains or receipts for those filers that fall in the new 39.6% tax bracket. ATRA permanently retains the 0% and 15% rates on qualified dividends and long term capital gains for other tax brackets.
IRA Charitable Rollovers
An IRA Charitable Rollover allows a donor to take an income tax deduction when s/he withdraws funds from a traditional IRA and donates those funds to a charity. Generally, when an individual makes a withdrawal from a traditional IRA, the withdrawal must be reported as ordinary income and taxed accordingly. However, when the withdrawn funds are donated to a charity, the individual may be entitled to an income tax deduction for the value of the donation.
This "IRA Charitable Rollover" allowance was set to expire in 2012. However, as a result of the new legislation, the charitable rollover has now been extended for 2 years, commencing with 2012. Additionally, charitable rollovers can still be made in January 2013 for the 2012 year.
For individuals who were required to take mandatory distributions for December 2012 as a result of the extension of the rollover, the distribution can still be donated to a qualified charity in January 2013 in order for the taxpayer making the distribution to avoid taxation.
Temporary Suspension of Payroll Tax not Extended
Prior legislation temporarily suspended a portion of the payroll tax and that suspension expired in 2012. The suspension was not extended under the new legislation and now, as a result, payroll taxes will rise 2% for most wage earners earning less than approximately $110,000.
No One is Falling Off the Fiscal Cliff!
There are still a number of spending issues to be ironed out between Congress and President Obama. In particular, they will be working to extend the debt ceiling so government can pay its bills on time and keep our standing in the world community intact. They are also looking for ways to cut spending in a fiscally, as well as socially responsible way. Much of the "fiscal cliff" panic created in part by certain lawmakers and in part by an over-zealous media was not necessary before and is certainly not necessary now. If you are in touch with your tax planning professional on a regular basis and keep your estate plan updated every three-five years, you should have no need to worry. If you would like to discuss how the new law will impact you, please contact either Frieda Gordon or Avery Cooper, who have over sixty years of combined experience in the areas of estate planning and estate and trust administration and litigation.