On New Year's Day, Congress approved the first permanent set of estate, gift, and generation-skipping transfer (GST) tax rates and exemptions in 12 years. Despite speculation and attempts over several years focused on options ranging from total repeal to a return to pre-2001 law, the law now made permanent by Congress is identical to 2012 law, except that the compromise rate is 40 percent rather than 35 percent.

The Senate approved this legislation in a bipartisan 89-8 vote a couple hours after 2013 had begun. The House of Representatives approved it an hour before midnight in a much less bipartisan 257-167 vote, with twice as many Democrats as Republicans supporting it.

Forty Percent Rate

The new 40 percent rate is up from the 35 percent rate of 2010 through 2012, but less than the 45 percent rate of 2009 law that had been the position of the Obama Administration. Indeed, 40 percent is the precise midpoint of those two positions, which had marked the boundaries of the debate at the end.

Unified Exemption

The exemption remains at $5 million, indexed for inflation since 2011, which places it at $5.25 million for gifts made and the estates of decedents dying in 2013.

Although the gift tax exemption was lower than the estate tax exemption from 2004 through 2010 and many viewed its "reunification" with the estate tax exemption in 2011 and 2012 as very fragile, Congress has chosen to keep the two exemptions the same, as well as the GST exemption, which is also $5.25 million for 2013.

With unified estate and gifts tax exemptions maintained at their 2011 and 2012 levels, we now know that the rush to make large gifts at the end of 2012 may not have been necessary. But there was no way to know that until a few hours after it was too late, when Congress finally acted. And if the timing of some of the gifts was dictated by the January 1 "sunset" that was on the books when 2012 ended, our sense is that those year-end gifts generally reflected serious thinking about estate planning priorities, responsibly provided younger generations with access to family wealth, and removed any future appreciation in transferred assets from the reach of the gift and estate taxes. Besides, it would be naïve to assume that Congress is done making changes to the tax law, even to the estate tax, and while permanence at last is a welcome relief, we know that it lasts only until Congress chooses to make more changes.

Changes Not Made – Yet

Among the possible changes that Congress did not make this time are significant Administration proposals for revenue-raising by limiting the benefits of grantor trusts, imposing a minimum ten-year term for grantor retained annuity trusts (GRATs), limiting the duration of the allocation of GST exemption, and reducing the availability of entity-based valuation discounts. Because Congress could embrace any or all of those proposals almost anytime, we still see reasons for significant estate planning in 2013, especially with the increased ability to make tax-free generation-skipping gifts that comes with the sustained and even inflation-indexed exemptions.

Portability

The December 2010 legislation introduced the "portability" of the exemption for gift and estate tax purposes, whereby the exemption not used by the first spouse to die would be available for use by the surviving spouse for gift tax purposes and the surviving spouse's executor for estate tax purposes (but not for GST tax purposes). Treasury Regulations published in June 2012 provided considerable clarity and welcome guidance regarding portability. Congress has now made portability permanent.

Other 2001 Changes

The New Year's Day legislation also makes permanent the relatively non-political technical provisions enacted in 2001, related to the allocation of GST exemption, the GST inclusion ratio, conservation easements, and the extension of time to pay estate tax under section 6166.

Other Tax Measures

Although estate and gift taxes are the principal focus of our analysis, because of their obvious importance to estate planning, it is well known that the New Year's Day legislation was a part of a broad if unruly rescue from a "fiscal cliff" by modifying and making permanent the "Bush tax cuts," extending certain employment benefits for a year, and postponing many of the "sequestration" effects for at least two months.

Significant tax measures approved January 1 include

  • reinstatement of the 39.6 percent individual income tax rate and 20 percent capital gains tax rate for taxable income over $450,000 for joint filers and $400,000 for single individuals;
  • return of the phaseout of personal exemptions and itemized deductions, but with higher thresholds for itemized deductions;
  • restoration of the IRA charitable rollover for 2012 and 2013 for individuals over 70½, with special rules for IRA distributions made in December 2012 and for charitable rollovers made in January 2013;
  • five-year extensions, through 2017, of the popular American Opportunity Tax Credit, Child Tax Credit, and Earned Income Tax Credit;
  • indexing the individual alternative minimum tax (AMT) exemption for inflation, in effect making the annual AMT "patch" permanent; and
  • extension of over 50 individual and business "extenders" (temporary provisions), generally for two years, 2012 and 2013.

In addition, beginning January 1, 2013, net investment income is subject to the new 3.8 percent Medicare tax if adjusted gross income (without regard to the foreign earned income exclusion) exceeds $250,000 for joint filers and $200,000 for single individuals. That makes the overall top federal rate on investment income 43.4 percent, to which state taxes are added. The 3.8 percent tax will also apply to the undistributed net investment income of trusts in excess of the level where the top income tax rate takes effect for trusts, approximately $12,000 for 2013.

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