The Effect of Fiscal Cliff Legislation on Estate Planning

In a previous post, Disclaimer Trusts – a Flexible Option in an Uncertain Estate Planning World, I discussed the uncertainty that the then looming “fiscal cliff” crisis created in the estate planning world.  Now that the “fiscal cliff” has been averted through the American Taxpayer Relief Act of 2012 (the “Act”), which was approved by Congress on January 1, 2013, such uncertainty has been eliminated.

Prior to the Act, in 2012 estates valued below $5,120,000 were shielded from the federal estate tax by the estate tax credit. If the Act had not been approved by Congress, beginning in 2013, the credit against the estate tax was scheduled to fall to only $1,000,000.  This created some confusion with clients who did not know if the estate tax would apply to them because their estate values fall somewhere between $1,000,000 and $5,120,000.

The Act did several things to clear up such uncertainty.  First, the Act has permanently set the credit against the federal estate tax at $5,000,000, indexed for inflation.  Thus, my clients whose estates are between the $1,000,000 and $5,000,000 values now know that the federal estate tax will not apply to them.

The Act also made the “portability” of the credit permanent.  The portability provisions essentially allow the estate of a decedent to make an election permitting his or her surviving spouse to transfer the unused portion of the decedent’s credit against the estate tax to the surviving spouse.  The surviving spouse can then use that additional credit against lifetime gifts and against the estate tax at his or her death. 

For example, if Bob passes and his estate uses only $2,000,000 of his credit, his estate can transfer his $3,000,000 unused credit to Betty, his surviving spouse.  Adding that amount to the $5,000,000 credit she already had, Betty now has an $8,000,000 credit that she can use against lifetime gifts or against the estate tax at her death.

Prior to the Act, the portability provisions with regard to the estate tax only applied where both spouses passed between December 31, 2010 and before January 1, 2013.  This meant it was rarely useful.  However, now that the portability provisions have been made permanent, they will generally be available to all decedents with a surviving spouse, no matter when the surviving spouse passes.

However, the elimination of uncertainty did not come without a cost. The Act raises the top tax rate on estates and gifts to which the tax applies from thirty-five percent to forty percent. Apparently, the debate over the federal estate tax was one of the potential deal breakers in the Senate. Republicans wanted a complete repeal of the estate and gift tax while President Obama sought a forty-five percent tax rate with a $3,500,000 credit. Thus, the changes made by the Act were the result of concessions by both sides.

Planning for your estate, especially if federal estate taxes may be involved, can be a complex matter.  However, it is also an important matter so I highly suggest consulting with an estate planning professional if you have any questions about your estate planning needs.

Matthew Grosh is an attorney at Russell, Krafft & Gruber, LLP in Lancaster, Pennsylvania.  He received his law degree from Villanova University and practices in a variety of areas including Estate Planning.