Following up on David Braun’s blog Fiscal Cliff Deal Benefits Land Conservation, here is a summary of the estate planning implications of the fiscal cliff deal, otherwise know as the American Taxpayer Relief Act of 2012 (“ATRA”), especially as they impact the owners of rural land. The result of the fiscal cliff deal ends much of the uncertainty regarding transfer tax rates and the amount of assets you can pass tax-free (the “exemption amount”), and makes it easier for families to transfer the farm or ranch or vacation house between generations without breaking up cherished property.
Since 2001, the estate tax laws have been changing almost constantly, making it very difficult for families to plan for the most efficient transfer of family lands between the baby boom generation and their successors. Had Congress not acted at the end of 2012 to avoid the fiscal cliff, many more Texas landowners would have been hurt by the drastically lower $1 million estate and/or gift tax exemption amount, and a 55% or even 60% generation-skipping transfer tax rate (to read more on this, see my previous blog, Impending Fiscal Cliff Presents Challenges to Gifting Legacy Land). This incoherent tax policy would have resulted in accelerated fragmentation of larger properties and their natural systems, habitat, and open space in Texas.
There are 3 main “permanent” changes to discuss from the fiscal cliff deal that end this period of uncertainty. But what Congress giveth, Congress can taketh away. Although these 3 changes are now “permanent”, that is, they are not scheduled to expire or sunset, pay attention to how Congress might change these rules in the future to increase federal revenues as part of the ongoing budget debate.
- Permanent $5 Million Dollar Individual Exemption Amount.
The amount of assets that you can pass between generations, either by lifetime gifts or under your will or trust, without being taxed, is now “permanently” set at $5 Million and is indexed for inflation. In 2013, this means dad can pass $5,250,000, and mom and dad together can pass a total of $10,500,000 to their children without any transfer tax. However, every dollar transferred over the exemption amount is subject to tax.
- Permanent Reduction in Estate Tax Rates.
The amount of the estate tax depends on the size of the taxable transfer at death and the tax rate. Had the fiscal cliff deal not passed, the tax rates would have returned to the 55% and even 60% levels from 2001. Here is a chart of these tax rates after the fiscal cliff deal was made. The rates start at 18% and quickly rise to 40% for each dollar over the exemption amount.
Thus, for an individual dying in 2013 with an overall estate of $6,000,000, and after applying the $5,250,000 exemption amount, their taxable estate would be $750,000. Their estate would have to pay $248,300 in estate tax, generally within 9 months from the date of death. As the chart indicates, the maximum tax rate is now capped at 40%.
- Permanent Portability of Unused Exemption Amount Between Spouses.
Couples can pass an unlimited amount of assets between each other without incurring federal gift or estate tax under the “unlimited marital deduction.” Before the advent of portability in 2010, if the husband died with a taxable estate, but gave everything to his wife, there would be no estate tax due as a result. The husband’s exemption amount was not needed because of the unlimited marital deduction, but it might also be wasted. If at the wife’s death the assets passing to their children exceeded the wife’s exemption amount, then her taxable estate would be subject to tax, regardless of her husband’s unused exemption amount.
Tax law changes in 2010 gave married couples the opportunity to transfer the first spouse’s unused exemption amount to the surviving spouse. Now at the second death, if the assets passing to their children exceeded the wife’s exemption amount, then her estate could also apply her husband’s unused exemption amount to shelter more of her taxable estate. But the 2010 tax law only allowed the portability of the unused exemption amount in 2010 through 2012. The fiscal cliff deal makes this portability permanent.
If used properly, portability will save many Texas farms and ranches from being sold off in pieces to pay estate tax. But there are complicated rules to follow to apply the first spouse’s unused exemption, and the tax law requires the surviving spouse to make important and irrevocable decisions at the first death. Ever increasing land values will also push more farms and ranches beyond the threshold of portability and the new inflation-indexed exemption amount. So please consult your estate planning attorney to determine how the changes made in the fiscal cliff deal apply to your particular case.