Gift, Estate and Generation Skipping Tax After the American Taxpayer Relief Act of 2012
In 2012, there was a federal estate tax in effect, with a $5,120,000 exemption per person. This exemption was temporary and would have been reduced to $1,000,000 unless Congress took action on or before December 31, 2012 to extend, reduce or increase the exemption.
On January 2, 2013, the American Taxpayer Relief Act was signed into law and it provides some measure of certainty regarding the federal estate tax. In essence, Congress made permanent the changes that went into effect in 2010, with the only significant change being made to the gift and estate tax rate, with a top rate of 40% from the prior top rate of 35%.
Under the 2010 law, each individual could transfer up to $5,000,000 tax free, during life or at death. This exemption amount is adjusted for inflation. For 2012, it was raised to $5,120,000 per person and we expect the exemption for 2013 to be $5,250,000 per person.
There is still an unlimited marital deduction from the federal estate and gift tax that operates to defer estate tax on assets inherited from a spouse until the second spouse dies. This marital deduction only applies if the inheriting spouse is a U.S. citizen.
The new law makes permanent “portability”, a change that went into effect in 2010. Portability enables a surviving spouse to add any unused exemption of the spouse who died most recently to their own unused exemption. In essence, a surviving spouse could transfer up to $10,500,000 federal estate tax free.
Nevertheless, while the unused exemption might be portable, it does not adjust for inflation nor is it automatic. The fiduciary of the estate of the spouse who died must transfer the unused exemption to the surviving spouse by filing a federal estate tax return. Further for some couples, relying on portability may not be the solution since portability is not recognized by the State of Illinois.
As of January 1, 2011, there was no Illinois estate tax; however, as part of the legislation that Governor Quinn signed which increased the state income tax, the Illinois estate tax was reinstated. Effective January 1, 2013, the Illinois estate tax exemption is now $4,000,000. There is no portability for unused Illinois exemption.
One simple way you can reduce estate taxes and, in limited circumstances, shelter assets to achieve Medicaid eligibility, is to give some or all of your estate to your children (or anyone else) during your life in the form of gifts. Certain rules apply, however. There is no actual limit on how much you may give during your lifetime. But if you give any individual more than $14,000 (increased from the $13,000 available in 2012), you must file a gift tax return reporting the gift to the IRS and use your available exemption to offset gift tax due.
The $14,000 figure is an exclusion from the gift tax reporting requirement. You may give $14,000 to each of your children, their spouses, and your grandchildren (or to anyone else you choose) each year without reporting these gifts to the IRS. In addition, if you’re married, your spouse can likewise make exclusion gifts. For example, in 2013, a married couple with four children could gift up to $112,000 to their children with no gift tax implications. In addition, the gifts will not count as taxable income to your children (although the earnings on the gifts if they are invested will be taxed).
In addition to the annual gift tax exclusion, payments directly to an institution for tuition or to a provider for medical expenses on someone else’s behalf, such as your child, are not treated as taxable gifts.