The year 2012 promises to be a watershed for federal estate, gift and generation skipping transfer (“GST”) tax law. Much to the potential chagrin of taxpayers, the significant and largely taxpayer friendly changes to the federal transfer tax system enacted in 2010 are set to expire at the end of this year if Congress does not take further action.
On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, And Job Creation Act of 2010 into law. This Act was passed as a temporary stop gap to a previous set of laws that expired in 2010. The 2010 Act was largely favorable to taxpayers, as it increased the amount of wealth that could be shielded from federal estate and gift taxes to $5 million per person, escalated annually for inflation, set the maximum marginal gift, estate and generation skipping tax rate at 35% (down from a maximum of 55% in recent years), and made the estate tax exemption portable between spouses, so that any unused estate tax exemption on the death of the first spouse could be transferred to the surviving spouse, to be used on his or her death. As a result, through the credits available to both spouses, a married couple can shield up to $10 million (indexed for inflation) from federal estate tax, and individuals can transfer significant wealth to their descendants through gifting.
Unfortunately, the changes brought about by the 2010 Act are set to expire at the close of 2012 unless Congress takes further action. If that happens, each individual will be able to pass only $1 million in assets (indexed for inflation) without being subject to Federal estate tax, the maximum gift, estate and generation skipping tax rate will increase from 35% to 55% and the portability option will be removed. In practical terms, the federal estate tax will impact many more individuals and families and the top estate tax rate will be 20% higher than under the 2010 Act. Of course, this is likely a worst case scenario, as Congress is predicted to enact further legislation.
What does this mean for you? For one, it is a good time to revisit your estate plan to ensure that it is functioning properly in anticipation of significant potential changes in transfer tax law. Through some planning, you can ensure that your ability to shield your hard earned wealth from estate tax is maximized. Second, for those impacted by the possible reduction in the federal estate tax exemption amount, it may also be a good time to consider removing assets from your estate, with strategies such as gifting, the use of irrevocable life insurance trusts, and charitable bequests.
While history has shown that it is difficult to predict changes Congress will make to the tax code, it has also shown that merely reacting to those changes can have serious consequences in the arena of estate planning. If you have not done so already, it may be a good time for you to contact your advisor to discuss your estate plan and how it will be impacted by the impending changes in tax law.