Feb. 4, 2013 | Financial Perspectives

On Jan. 1, 2013, Congress averted the so-called fiscal cliff by approving new legislation titled the American Taxpayer Relief Act of 2012 (ATRA-2012).? President Obama signed the bill into law.

The new law will extend the Bush-era income tax cuts for 98 percent of U.S. taxpayers, but also extends the sweeping changes made to the federal estate and gift tax rules originally enacted under the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Act).

Higher Taxes for High-Income Earners

The backdrop for these changes is a change in the effective tax rates for the highest earners. The act makes permanent the tax cuts enacted as part of the 2001 tax act, so that for most Americans, the prior tax rates remain in effect. But higher-income folks face a tougher income tax regime.

• A new 39.6% top marginal tax bracket has been added for those earning over $400,000 for single taxpayers, $425,000 for head of household taxpayers, and $450,000 for married taxpayers.
• These same high earners will also face a new higher 20% tax rate on dividends and capital gains.
• These rates are further aggravated by the 3.8% Medicare tax on investment income, which also applies starting in 2013 on adjusted gross income over $200,000 for singles and $250,000 for married couples.
• Itemized deductions and personal exemptions are phased out on income of $250,000 single and $300,000 for married couples filing jointly.

When all these factors are combined with state income taxes, the affluent could face a combined tax rate of more than 50%.

Extended Estate & Gift Tax Relief

ATRA-2012 generally extends current estate and gift tax policy, centered on a $5.12 million unified exemption amount, which will be further increased for inflation to $5.25 million (or twice that amount for married couples) for 2013. The generation-skipping transfer tax exemption is also extended at the inflation-indexed amount of $5.25 million.? The single modification ATRA-2012 makes to these rules is an increase in the top tax rate on transfers above the exemption amount from 35 percent to a new maximum tax rate of 40%.

These changes are quite dramatic considering that the exemption amount would have reverted to $1 million, and the top estate tax rate would have ballooned to 55% if Congress hadn?t acted to avoid the fiscal cliff.

Quite significantly, the new law is permanent, which is a welcome departure from the uncertainty that has surrounded federal tax policy over the past decade.? Congress established the permanency of the new legislation by striking the ?sunset? provision from the original Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).

Other Important? Estate Tax Rules Extended

Unification.? ATRA-2012 extended the 2010 reunification of the exemption amount for estate and gift tax purposes, meaning the exemption may be used during lifetime to make tax-free gifts or at death to shield bequests from the estate tax.? (EGTRRA had ?de-coupled? the estate and gift tax systems, limiting the gift tax exemption to $1 million, while incrementally increasing the estate tax exemption.)? The extension of the unified exemption amount will continue to provide affluent families with tremendous flexibility to transfer wealth to children and grandchildren in a tax-efficient manner.

Portability.? ATRA-2012 also extends the ability of a deceased spouse?s estate to transfer any unused portion of the deceased spouse?s exemption amount to a surviving spouse.? (Prior to 2011, careful trust planning was required to ensure that married couples didn?t ?under-use? their respective estate tax exemptions at the death of either spouse.)

For example, assume Husband dies in 2013 having made lifetime gifts to children, consuming $2 million of his exemption.? At death, he leaves his remaining $3.25 million estate to his surviving spouse.? The executor of Husband?s estate may elect to permit the surviving spouse to use Husband?s unused $3.25 million exemption, giving the surviving spouse an $8.5 million exemption (her original $5.25 million exemption, plus the deceased spouse?s $3.25 million unused exemption).

Review Estate Documents

By making the current estate and gift tax rules permanent, Congress has ensured that the vast majority of U.S. taxpayers won?t be subject to federal estate taxes.? Nevertheless, the benefits of having a qualified estate-planning attorney prepare a comprehensive and thoughtful estate plan will continue to be important and beneficial to individuals and families.? A good set of estate-planning documents should generally include: a revocable living trust, a pour-over will, a power of attorney for financial matters and advanced health care directives.? In light of the rule changes outlined above, individuals should review their existing estate-planning documents.

Source: http://www.financialperspectives.biz/app/webroot/blog/?p=965

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