Changes to income taxes grabbed the lion’s share of the attention as the President and Congress squabbled over how to halt the country’s journey towards the “fiscal cliff.” However, negotiations over exemptions and tax rates for estate taxes, gift taxes and generation-skipping taxes also occurred on Capitol Hill, albeit with less fanfare.
The primary fear was that Congress would fail to act and the estate tax exemption would revert back down to $1 million. This did not happen. The ultimate legislation that was enacted, American Taxpayer Relief Act of 2012, maintains the $5 million exemption for estate taxes, gift taxes and generation-skipping taxes. The actual amount of the exemption in 2013 is $5.25 million, due to adjustments for inflation.
The other fear was that the top estate tax rate would revert to 55 percent from the 2012 rate of 35 percent. The top tax rate did rise, but only 5 percent from 35 percent to 40 percent.
The American Taxpayer Relief Act of 2012 also makes permanent the portability provision of estate tax law. Portability means that the unused portion of the first-to-die spouse’s estate tax exemption passes to the surviving spouse to be used in addition to the surviving spouse’s individual $5.25 million exemption. There are many rules regarding portability that must be followed.
Federal Estate Tax Law Definitions and Additional Explanations
The federal estate tax is imposed when assets are transferred from a deceased individual to surviving heirs. The federal estate tax does not apply to estates valued at less than $5.25 million. It also does not apply to after-death transfers to a surviving spouse. Be aware that many states also impose a separate state estate tax.
The federal gift tax applies to any transfers of property from one individual to another for no return or for a return less than the full value of the property. The federal gift tax applies whether or not the giver intends the transfer to be a gift. In 2013, the lifetime exemption amount is $5.25 million at a rate of 40 percent. Gifts for tuition and for qualified medical expenses are exempt from the federal gift tax as are gifts under $14,000 per recipient per year.
The federal generation-skipping tax (GST) was created to ensure that multi-generational gifts and bequests do not escape federal taxation. There are both direct and indirect generation-skipping transfers to which the GST may apply. An example of a direct transfer is a grandmother bequeathing money to her granddaughter. An example of an indirect transfer is a mother bequeathing a life estate for a house to her daughter, requiring that upon her death the house is to be transferred to the granddaughter.