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The American Taxpayer Relief Act Of 2012-Friend or Foe?

By: Randall A. Denha, J.D., LL.M.

In a cruel twist of legislative wrestling, while the citizenry raced to complete year-end tax planning and complete year end gifts that were put off combined with the media frenzy of whether we were going off the “cliff”, Congress passed the “American Taxpayer Relief Act of 2012″ (“the 2012 Act”) on New Year’s Day. President Obama signed the 2012 Act into law on January 2, 2013. The new law has important – and mostly positive – consequences for the federal estate, gift and generation-skipping transfer (GST) taxes. Overall, the 2012 Act prevents tax-rate increases for the vast majority of taxpayers by making permanent many of the Bush-era tax breaks that had been scheduled to expire at the end of 2012. Higher-income taxpayers (defined in the 2012 Act as individuals with income above $400,000 or married couples with income above $450,000) will face significant tax increases through a combination of higher rates and limits on itemized deductions. Since the passage of the 2012 Act, much has been reported in this area so the following is a very brief table that shows the various income tax rates for 2013:

Individual income tax rates for 2013
Taxable income*
Single Joint
$0+ $0+
$8,950+ $17,900+
$36,250+ $72,500+
$87,850+ $146,400+
$183,250+ $223,050+
$200,000+ (AGI) $250,000+(AGI)
$398,350+ $398,350+
$400,000+ $450,000+
Ordinary income Capital gains and dividends
10% 0%
15%
25% 15%
28%
33%
35%
39.6% 20%
Medicare tax
Earned income** Investment income
2.9% 0%
3.8% 3.8%
*Based on estimated 2013 inflation adjustments. Amounts refer to taxable income expect where noted.
**Combined rate includes 1.45% employer contribution.

A Key point worth mentioning is that a “stealth tax” called the Pease provision was included as part of the 2012 Act. In effect, this sleight of hand increases tax liability without increasing tax rates. How? It operates as an income-based reduction in the amount of itemized deductions higher-income taxpayers can claim. Personal exemptions and itemized deductions will be phased out at new thresholds: $250,000 for single taxpayers and $300,000 for married taxpayers filing jointly. All in all, you will not be able to deduct all that you think you can!

The 2012 Act also provides for the following:

  • The estate, gift and generation skipping exemption (“GST”) is $5,250,000 ( for a single) or $10,500,000 (married couple who elects to split the gifts), indexed for inflation;
  • The maximum estate, gift and GST tax rates have increased to 40%.
  • The above rates are “permanent”-until Congress decides to change them again (HINT)
  • Estate tax portability is permanent. Portability permits a surviving spouse to apply the unused estate tax exemption of the first spouse to die to the surviving spouse’s own lifetime or testamentary transfer. In the past, the first spouse’s unused exemption would have been lost if the first to die failed to put together an estate plan.)

Planning Considerations

Other than the myriad of income tax planning opportunities which exist in the 2012 Act, there exist a number of opportunities under the 2012 Act in the areas of estate, gift and GST planning such as:

  • Preparing and/or updating your estate planning documents consisting of a pour-over will, living trust, financial power of attorney and health care power of attorney. It is very important that you review and revise and always plan for flexibility in mind;
  • Making lifetime gifts of annual exclusion amounts (currently $14,000 (single) or $28,000 (married) indexed for inflation to anybody you want;
  • Roth conversion is now permitted for anyone and at anytime. Of course you will have to pay income taxes on the value of the plan that is rolled over. If you feel that income taxes are likely to increase in future years and you have money outside of the retirement plan with which to pay the income tax then it may be a worthwhile option.
  • Family LLCs will continue to thrive under the 2012 Act. Why? Many Grantors do not want any gifts they make to be dissipated or taken by a creditor but instead wish for that asset to be protected for the Grantor’s intended beneficiary. Because of the Pease Amendment (discussed above), many high-income wage earners will find deductions disappearing and for this reason will look to Family LLCs as a way to shift income and qualifying deductions to this entity (subject to tax rules.) It is my prediction that the Family LLC will not only be utilized for the valuable estate and gift tax benefit it provides, but the income tax benefit that it now presents in opportunity shifting.
  • Reviewing any irrevocable trusts established for children and/or grandchildren so that its intended purpose is still being met. Just because you may no longer face an estate tax doesn’t necessarily mean that you should terminate the trust and give the assets to the children and/or grandchildren. Remember divorces and creditor attacks can wreak havoc on an outright distribution so be careful of the environment in which you gift.
  • If you didn’t use your previous gift tax exemption in 2012 (or earlier) then don’t worry because it’s still here and it’s a larger amount. The amount is $5,250,000 per spouse!
  • If you did make the gift of the full exemption then feel free to “top off” that gift by using an additional $130,000 per spouse to make additional transfers ($5.25 million less $5.12 million in 2012). Techniques involving sales to defective trusts, GRATs, FLLCs combined with the foregoing are very popular currently as an efficient method of wealth transfer.
  • Asset protection planning is going to be very popular as the increased gift tax exemption will permit more wealth to be transferred to protective trusts. One technique that is always in vogue is the third party asset protection trust and venues like Nevada, Alaska, Delaware or South Dakota are all jurisdictions that should receive your attention.

Recall that Congress has many more rounds of deficit reduction talks so the axe can still come down on any one of our favorite techniques. Several estate planning techniques that have been targeted by proposed legislation in the last few years are not addressed in the 2012 Act. For example, proposals have been floated to impose a mandatory minimum term for GRATs, curb valuation discount planning, limit the duration for which a so-called “dynasty” trust will be exempt from the GST tax, and limit or end a donor’s ability to make a completed gift to a trust and thereafter pay the trust’s income taxes as if they were the donor’s own.

THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.

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