By Robert B. Wolf, Esq.
Tener, Van Kirk, Wolf & Moore, Pittsburgh, PA
There is something about our new Tax Law - American Taxpayer's Relief Act - that reminds me of the opening scene in the original Star Trek series where William Shatner describes the mission of the Starship Enterprise, and if I may paraphrase his description for the estate planners of today: "our mission, is to explore strange new tax worlds, to seek out new techniques and new approaches, to boldly go where no estate planner has gone before." Today we live in a tax world where for many of our clients the force of gravity has literally been reversed. Things that used to fall down now fall up! It is a world where for many clients having an asset included in her estate may be a good thing rather than a bad thing, whereas for others, it will continue to be a very bad thing.
Nothing this revolutionary to the field of estate planning has occurred during my career as an estate planner starting in 1974.
In 2013, we now have the ability to give away up to $5.25 million per person without fear of US gift tax, federal estate tax or generation-skipping transfer tax.
And those limitations are both "permanent" and indexed so they will not be eroded by inflation.
Now whether the changes are really permanent or whether this in fact depends upon what the meaning of the word "is" is, we just don't know. But clearly the tax rules are at least not scheduled to change, or expire, or sunset, or whatever, by their very terms.
And now we have the ability to give to a surviving spouse any of that applicable exclusion amount we have not used or needed for federal gift tax or federal estate tax. This is called "portability" and may radically change many clients estate planning needs and the best tools and techniques to address those needs.
On the other hand, while the generation-skipping transfer tax will have the same $5.25 million indexed exemption as does the gift tax and federal estate tax, it is not portable between spouses, and this significantly affects long term dynasty trust planning.
At the same time, the federal estate tax rate for those over these limits rises to 40% from 35% last year. A significant increase, but a far cry from the 55% rate and $1 Million Exclusion amount awaiting us at the bottom of the fiscal cliff.
Most importantly, the income tax on higher income taxpayers will go up significantly, and as we have come to expect, very confusingly:
You may notice that the thresholds which politically define "middle income" Americans are essentially all different, so our political leaders can all point to some change that they believe in or at least for which they can take credit.
We have already this year noted the effects of these income tax increases on a client of ours of very modest means who has an opportunity to sell a valuable piece of family real estate whose gain on sale would push her into an almost 27% bracket on the long-term capital gain counting the 20% higher capital gains tax rate plus the 3.8% Medicare Tax and the 3.07% Pennsylvania tax, not to mention wiping out her deductible medical expenses and extinguishing the rest of her itemized deductions with the gross income phaseout.
The income tax effects of the new taxes and phase-outs that a chart is attached that may be useful to visualize the 2013 tax rates on qualified dividends and capital gains. Because of the phase-outs and thresholds, there are important "bubbles" in the tax structure for our higher (but not highest) income clients. A married couple with three dependent children with AGI of $350,000 gets a marginal capital gains tax or qualified dividend tax rate of 24.82%, about 5% of which comes from the personal exemption phase-out between $300,000 and $425,000.
Collectively, these changes are huge for the estate planning and tax planning community:
Bottom line changes:
Remember that today the divorce rate is now higher than the federal estate tax rate and trust planning and prenuptials are the first line of defense for the financial consequences of divorce.
Formula marital and credit shelter trusts have become much less popular in our recent age of uncertainty. Going forward, they should be used with considerable caution. The virtues of flexibility have been critical in this protracted age of extraordinary uncertainty, and should not be ignored.
The use of disclaimers in trusts and estate planning may increase.
The use of income tax stretch benefits for IRAs and other retirement accounts will assume increasing importance.
And then there are the families for whom we cannot really tell whether or not the federal estate tax may be important later. In those mezzanine situations, careful consideration must be given and discussions conducted with the client to determine goals, discuss risks and to select planning techniques and documents which address those goals and minimize those risks.
We certainly live and are practicing law in interesting times.
2013 Federal Tax Rates on Qualified Dividends & Capital Gains
Married Filing Jointly
0 to 36250
0 to 72500
18.8% Bracket--15% plus the 3.8% Net Investment Income Tax
3.8% Net Investment Income Tax & 3% phaseout of excess itemized deductions up to 80% of itemized deductions
Net effect of 3% phaseout is 1.05% at 35% rate and 1.19% at 39.6% bracket but if AMT applies, effect will be minimal or 0
20.8196%--18.8% Plus .99% for Exemption Phaseout plus 1.0296% for personal exemption phaseout
3.8% Net Investment Income Tax & 3% phaseout of excess itemized deductions up to 80% of itemized deductions and phaseout of personal exemptions
Net effect of 3% phaseout is .99% at 33% rate, 1.05% at 35% rate and 1.19% at 39.6% bracket but if AMT applies, effect may be minimal or 0
21.8492%--18.8% Plus .99% for Exemption Phaseout plus 2.0592% for personal exemption phaseout--24.8192% for married couple with 3 children
Net effect of 2% phaseout of personal exemptions per $2,500 in income is 1.0296% per exemption at 33% rate, 1.092% at 35% rate and 1.236% at 39.6% rate
AGI Lower Limit Taxable Income Upper Limit
Personal Exemption phaseouts completed
Tax is flat rate at 20% plus the 3.8% Net Investment Income Tax but note 3% phaseout of itemized deductions continues
No income ceiling on 3% phaseout of itemized deductions-Limited by 80% of itemized Deductions--may be nullified by alternative minimum tax calculation except charitable contributions are excluded from AMT calculation but not phaseout!