On Jan. 2, 2013, the American Taxpayer Relief Act was signed into law. For the most part, the Act extended what had been in effect for the last two years. Many people have asked me how permanent this makes estate tax exclusions and gift tax exclusion. My response is that it is as permanent as Congress wants it to be. In other words, because it is not written into the Constitution, the permanency is subject to the shifting political winds in Washington, D.C.
Overall, the Act appears to be favorable to farmers. The ability to exclude $5.12 million dollars from estate tax was increased to $5.25 million. So, a married couple together can exclude 10.5 million dollars from estate taxes. In addition, the Act kept in place that spouses do not pay tax on what they inherit from each other. Thus, there is an unlimited deduction from estate and gift tax that postpones the tax on assets inherited from each other until the second spouse dies. This is referred to as the “marital deduction.”
The Act also continues to have the gift tax exemption to be equal to that of the above stated estate tax exemption. This means that a person can gift, tax free, $5.25 million dollars in assets during their lifetime, and a married couple can gift a total of $10.5 million dollars.
It is important for readers to understand that the estate tax exemption of $5.25 million dollars and the gift tax exemption of $5.25 million dollars are to separate exemptions, but come out of the same pot. For example, if you gift $1 million dollars during your lifetime and apply that towards your gift tax exemption, your estate tax exclusion amount will drop to $4.25 million. So, the $5.25 million is an “either-and-or” exemption. You “either” use it while you are alive via gifting, “and/or” have your estate utilize it after your passing.
As for yearly gifting, the Act increases the amount a person can gift, tax free, from $13,000 in 2012 to $14,000 for 2013. This yearly amount does not count against your $5.25 million gift tax exemption. So, a married couple can make a joint cash gift of $28,000 to each of their children without incurring any gift tax liability. Only gifts to a person that exceed the $14,000 limit (or $28,000 from a married couple) count against the lifetime gift tax exemption.
The Generation Skipping Transfer Tax (GST) is a tax that is assessed on transfers during lifetime, or after death, to a grandchild or more remote descendant. The Act allows for a person to shield up to $5.25 million dollars of assets that are left to grandchildren or other remote descendants.
The Act also extends the “portability” option that allows the executor or trustee of a deceased spouse to elect to give the deceased spouse’s unused federal estate and gift tax exemption to the surviving spouse. Prior to the Act being passed, this option was set to expire. However, the portability option does not extend to the GST tax exemption. Before the portability option, the use of the deceased spouse’s estate tax exemption had a “use it or lose it” requirement. If the deceased spouse’s assets were not parked, within a certain time, in a credit shelter trust, then the credit was lost. While I do think the portability option is important, one drawback of utilizing it is that growth and income on the deceased spouse’s assets will not be locked in and exempt from tax.
Even with the portability option, I do think it is important for married couples to have the proper trust that allows, at the death of the first spouse, the estate tax exemption be used to fund the deceased spouse’s credit shelter trust. That way, any appreciation in the assets will not be subject to tax.
For example, a husband passes away and his credit shelter trust is funded with $5.25 million dollars of farm real estate. The wife would be able to receive the income generated by the assets in the trust. Even if the farm real estate appreciates above and beyond the $5.25 million, all the assets in the trust can pass to the children, tax free, at the death of the second spouse, regardless of how much the real estate has appreciated.
On the downside, the Act increased the maximum tax rate from 35 percent to 40 percent for amounts above the estate exemption and gift exemption. Hence, for those estates above the exemption amounts, not having the proper plan in place will be more costly under the Act.
Although the Act generally keeps in place the favorable provisions that existed in 2011 and 2012, more changes may be forthcoming.
In addition, it is important to have an estate plan that takes advantage of the provisions of the Act. I am hopeful that the passage of the Act does not lull farm families into complacency. Rather, farm families should remain vigilant in ensuring they have a plan that meets their goals, regardless of what Congress does, or does not, do.
Lastly, with the ever increasing value of farm real estate and machinery, smaller farms may have estate values that exceed the exemption amounts. So, even though the Act kept the higher estate and gift exemptions, my guess is that more and more farms will be over the exemption amounts as time goes on. Now that Congress has set the rules, at least for now, families should review their plan and make sure it takes advantage of what the Act allows.
John J. Schwarz, II, farms 2,500 acres with his family near Stroh, Ind., and is an agricultural law attorney and farm estate planner. He can be reached at 260-351-4440 or at John@Schwarzlawoffice.com Readers can find more information at www.farmlegacy.com