Year End Tax Planning

As we have discussed in our prior newsletters, and as summarized in numerous news articles about the impending "fiscal cliff," important tax changes will occur January 1, 2013 unless Congress takes action
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$5,120,000 Gift and Estate Tax Exemption Ends. In 2012, each U.S. citizen and resident has a $5,120,000 gift and estate tax exemption. In 2013, that exemption will be $1 million unless Congress acts. If one makes a $5 million gift (assuming no prior taxable gifts) in 2012, no gift tax would be due, but that gift will be taken into account in computing the estate tax at the donor’s death. If the exemption had decreased, estate tax would be due. However, such a gift will be effective to remove all future income and appreciation on the gifted assets from the donor’s estate. We had suggested that clients may want to consider the creation of a "Lifetime Credit Shelter Trust" that could benefit the donor’s spouse and children. If each spouse wants to create such a trust for the benefit of each other, they must be careful to avoid the "Reciprocal Trust Rule" because if the rule were applied and a donor is deemed to create a trust for the donor’s benefit, all of the trust property would be included in the donor’s estate under Code §2036(a). Usually, in order to avoid the Reciprocal Trust Rule when both spouses create an irrevocable life insurance trust, we have recommended creating the two trusts at least six months apart. That is no longer possible at this late date in 2012. It would still be possible for one spouse to create an irrevocable trust for the benefit of spouse and descendants, and the other spouse to create an irrevocable trust only for the benefit of the descendants. IF YOU WANT US TO WORK WITH YOU TO CREATE SUCH A TRUST, YOU MUST CONTACT US BY NOVEMBER 15, 2012. Preparing the trust agreement(s) with the desired terms and obtaining necessary appraisals of the gifted assets require time. DO NOT WAIT UNTIL THE HOLIDAYS TO CONTACT US.
Generation-Skipping Transfer Tax Exemption. If Congress fails to act, the GST exemption will be $1,430,000 based upon increases for inflation from 2001. The tax rate will be 55% (the 2013 top estate tax rate), up from 35% in 2012.
Increase in Capital Gains tax rates. In 2012, the tax rate on capital gains is 15%. In 2013, if Congress fails to act, the maximum long-term capital gain rate will be 18% on assets held more than five years and 20% on assets held less than five years, but more than one year.
Increase in tax rate on dividends. In 2012, qualified dividends are taxed at a 15% rate. In 2013, if Congress fails to act, all dividends will be taxed as ordinary income. Because dividends are taxed in 2012 at the same rate as long-term capital gains, it was not important whether a distribution from a corporation was characterized as a dividend or a redemption. That distinction will again become important when the rates are different.
Increase in tax rates generally. The Bush tax cuts will expire at the end of 2012. The tax rates under the 2001 Act ranged from 10% to 35%. In 2013, if Congress fails to act, the rates will range from 15% to 39.6%.
3.8% surtax on investment income. In addition, starting in 2013, a 3.8% surtax will apply to the lesser of (1) net investment income or (2) the excess of modified adjusted gross income over the threshold amount: $250,000 for joint filers, $125,000 for married filing separately and $200,000 for other taxpayers. For estates and trusts, the tax is 3.8% of the lesser of (1) undistributed net investment income or (2) the excess of adjusted gross income over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins (Only $11,650 in 2012).
Annual Exclusion Gifts. For some good news, the gift tax annual exclusion that is $13,000 per donee in 2012 is expected to increase to $14,000 per donee in 2013. DON’T WAIT TO MAKE YOUR ANNUAL EXCLUSION GIFTS FOR 2012. Go ahead and make them now, and then make your 2013 annual exclusion gifts in January.
Estate Tax Statistics. As reported by Jonathan Blattmachr to the ACTEC listserv, 4,600 estate tax returns were filed in 2011, down nearly 70% from 2010, which was down 55% from 2009. Net estate tax receipts was $3 billion in 2011, down from $13 billion for 2010 and $20+ billion for 2009.

Federal Law News Flash!

On June 15, 2012, Treasury issued temporary and proposed regulations which give clarity and guidance as to the application, use and limitations on the portability of the unused estate tax exemption of the first spouse to die. In particular, the IRS clarified how the portable amount of estate tax exemption is calculated, and how that amount can be used by the surviving spouse, both for lifetime gifts as well as at death. Treasury calculates the surviving spouse’s exemption in a way that is favorable to taxpayers: The first spouse’s unused exemption (calculated in the year of death and pursuant to a timely filed U.S. Estate Tax Return) is added to the surviving spouse’s exemption. This means that if the first spouse dies in 2012 with $5 million in unused exemption; his estate timely files a Form 706; and surviving spouse dies in 2013 with a $1 million exemption because of the change in federal law, the surviving spouse’s estate will have a $6 million total exemption. Earlier, commentators had interpreted the statute as limiting the surviving spouse’s total exemption to two times the exemption available at the survivor’s death (or a total of $2 million in the example described above). This favorable interpretation makes it even more important to consider filing a Form 706 at the first death.

Guidance on 2011 Decedents and "Portability"

The IRS just released new guidance for personal representatives regarding electing portability of the deceased spouse’s unused estate tax exclusion amount and to potentially double the estate tax exemption that will be available at the surviving spouse’s later death. Notice 2011-82 confirms that the "portability" election must be made on a timely filed Federal Estate Tax Return (Form 706) and provides that the timely filing of a Form 706 "prepared in accordance with the instructions" will constitute the making of the portability election; therefore, by simply filing the Form 706, the estate will be considered to have elected portability "without the need to make an affirmative statement, check a box, or otherwise affirmatively elect." The Notice also provides that an estate may avoid making the election by following the instructions for the Form 706, which describe the necessary steps. For more information, go to http://www.irs.gov/pub/irs-drop/n-11-82.pdf.

Form 8939 and 2010 Decedents

Under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the "Act"), the estate of a 2010 decedent can either stay with the estate tax system with a $5 million exemption, 35% tax rate and full stepped up basis to date of death value, or make an election out of the estate tax system and into the carryover basis system by filing a Form 8939. Form 8939 is due November 15, 2011 according to IRS Notice 2011-66, but the Form itself has still not been released. There will be no extensions of the November15, 2011 due date and the election, once made, is irrevocable, according to the Notice. See our  January 2011 newsletter for a more complete discussion of the Act.
　

2011 Decedents and "Portability"

If a 2011 decedent is the first spouse to die, then in order for the surviving spouse to potentially double the estate tax exemption that will be available at his or her later death, under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “Act”) “portability” of the deceased spouse’s unused estate tax exemption must be elected on a timely filed U.S. Estate Tax Return (Form 706).  A draft of the 2011 Form 706 was released by the IRS on August 26, 2011, but does not seem to include a place to elect portability.  You may want to file a Form 4768 by the due date of the Form 706 (usually 9 months after date of death) to request an automatic 6-month extension and perhaps by then the manner of electing portability will be clear. See our January 2011 newsletter for a more complete discussion of this Act.