The New Changes to the American Estate Tax
- When Congress chose to increase the estate tax to $5 million and set the tax rate at 35%, many regarded the decision as an utter surprise. However, there is nothing surprising about this compromise. The Senate had already decided that it would set the exemption at the $5 million dollar amount before the debate began. The Senate had previously determined that a lower exemption amount and a higher tax rate did not have enough support to pass the Senate.
- Many have regarded the increase in the exemption as an indication that this will bring certainty to the estate tax. This is not the case. Congress only extended the estate tax for two years; therefore, the estate tax is set to expire in 2013 and the future of this estate tax will be uncertain again.
- Some Americans believe that they will not have to worry about the estate tax because the exemption is set at a high enough value to exclude most of the general population. However, this is inaccurate because it fails to take into consideration other components of their estate. Furthermore, the amount of the federal income tax exemption does not have anything to do with estate taxes that are imposed by the states or how the gift tax might affect a client’s estate.
- There are some that believe that the exemption will make it so that taxpayers will not have to file a gift or estate tax return. However, whether a client has to file a gift tax or estate tax return has nothing to do with the exemption. A taxpayer must still file a tax return and report any gifts that exceed the statutory exclusion. There are other important aspects of filing an estate or gift tax return. First, it begins the statute of limitations for a challenge by the IRS. The statute of limitations only applies if you file an income tax return. Second, a married spouse must file a Form 706 to take advantage of the portability of the exemption so that the surviving spouse can report Deceased Spousal Unused Exclusion Amount to the IRS.
- These next few myths deal with the portability provision discussed above. The first misconception is that the portability provision will simplify estate planning; however, the mechanism that it employs is confusing. When a spouse dies, the surviving spouse can take the remainder of the unused exemption. Now, if the surviving spouse re-marries and the new spouse dies, the surviving spouse loses the first unused exemption and gains the second spouse’s unused exemption.
- There is also a rumor that taxpayer will no longer use the unified credit trust because of the availability of the portability provision. This does not take into account that the estate tax exemption may not be as generous in the coming years. These options are still useful, especially if Congress decides to decrease the estate tax exemption.
- Some argue that the use of trusts for estate planning purposes will decrease, but this will probably not be the case. Trusts are used for a variety of estate planning purposes, most importantly creditor protection. The increase in the estate tax cannot diminish this important aspect of trusts.
- Some people have made the same argument for life insurance. However, like trusts, the increase in the estate tax does not frustrate the purpose of life insurance. A policyholder often purchases life insurance to replace wealth or provide an increase in wealth if that person is not able to provide enough wealth to take care of their family after their death.
- Finally, the myth that this increase in the estate tax will decrease the amount of gifts that are granted is wrong. As I have previously discussed, along with the increase in the estate tax exemption, Congress granted taxpayers the ability to transfer up to $ 5 million dollars in generation-skipping gifts tax-free.
See Ted Kurlowicz, Myths and Realities of the New Estate Tax Changes, The Wealth Channel (2011).
Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.
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