Fiscal cliff negotiations between Congress and the White House present risk that estate and gift tax exemptions will be reduced and that tax rates will be increased to add revenue as part of a package deal. Based on potential outcomes of the discussions, McManus & Associates today released insight on the future of estate planning and guidance on staying protected moving into 2013 via a conference call with clients.
"With both sides of the political aisle trying to win popular support by touting their attempts to compromise, a deal to avoid falling off the Fiscal Cliff may be reached," commented John O. McManus, top AV-rated attorney and founding principal of McManus & Associates. "But offers for compromise proposed by each side have been more focused on political posturing than real work for a solution."
1. What happens if a compromise on Fiscal Cliff negotiations is not reached by December 31, 2012?
a. Rates for individual income tax jumps to 39.6% (with an additional 3.8% on investment income, effectively equivalent to =43.4%).
b. Dividends rates rise from 15% to the ordinary income rate.
c. Estate tax exemption drops from $5.12 million to $1 million and any assets over that amount will be taxed at a rate of 55%, up from 35%.
d. Lifetime gift tax applicable exclusion amounts will be reduced to $1 million, and the Generation Skipping Transfer tax applicable exclusion amount, indexed for inflation, will be reduced to approximately $1.4 million.
e. The capital gains tax rate will increase to 20%.
f. The amount of the annual gift tax exclusion will increase from $13,000 per donee in 2012 to $14,000 per donee in 2013 (a married couple will be able to gift $28,000 to each donee).
g. The amount of the annual gift tax exclusion with respect to gifts made to non-citizen spouses will increase from $139,000 to $143,000 in 2013.
2. What are the potential compromises regarding gift tax/estate tax?
a. Repeal the estate tax - Completely eliminate the estate tax; part of former presidential hopeful Mitt Romney's plan (this has very little chance of happening).
b. Extend current rates - Keep the current exemption rates and tax percentages; let next year's Congress fill in the details and do the real reform work.
c. Obama's compromise - The President's plan of $3.5 million death exemption, $1 million gift tax and rates jumping to 45% (more likely).
* The death tax exemption, however, has support from both sides of the political aisle to remain at a higher amount.
"The emotional front-runner leading the charge to abolish the death tax is the example of the American Farmer," explained McManus. "With large land holdings and expensive farm equipment, farmers often have large estates without much liquidity. In order, therefore, to pay estate taxes with rates as high as 55 percent, many American farmers must sell the family farm to raise the cash needed to pay the taxes."
McManus continued, "Several powerful Democrats represent states with significant constituencies of family farmers that oppose this estate tax. To maintain their position in elected office, even Democratic leaders like Sen. Max Baucus (MT), Senate Finance Committee chair, have supported upholding the higher levels of exemption amounts for the death tax."
d. Do nothing - If this happens, we fall off the proverbial cliff, and the estate tax exemption and the lifetime gift tax exemption drop to $1 million with a 55% estate tax rate.
e. Something else - There is a possibility that a completely new plan could be devised to create a heretofore otherwise unmentioned compromise.
3. The 3.8% Medicare tax on capital gains, dividends, the highest tax bracket and the "Green Book" propositions - how will estate planning be impacted?
a. Effective next year, IRC 1411, the newly ratified 3.8% tax to fund the Affordable Healthcare Act, commonly known as "Obamacare," will take effect for individuals earning more than $200,000 and joint filers earning more than $250,000.
b. However, powerful Democrats including Chuck Schumer (NY) and Nancy Pelosi (CA) have pushed for raising the $250,000 threshold to $1 million.
c. We have an active defense budget, social security liabilities and social safety net programs that require nearly $3.8 trillion in funding, so it is unlikely that taxes will go down.
d. 2013 Green Book - Obama has outlined several new potential issues for estate planning for the coming tax year. These issues will be in negotiations:
i. Reducing or eliminating valuation discounts for "family-controlled" entities by creating a category of "disregarded restrictions."
ii. Requiring a minimum 10-year term for grantor retained annuity trusts (GRATs) and eliminating the ability to create a "zeroed out" GRAT.
iii. Limiting the duration of generation-skipping transfer tax to 90 years.
iv. Subjecting any trust that is treated as a grantor trust for income tax purposes to estate taxes in the grantor's estate.
v. Reverting to the 2009 exemption amounts and rates for estate and gift taxes ($1 million exemption for gift tax, $3.5 million exemption for estate tax, and a rate of 45% for any amount over the exemption amount).
"Congress may use the final weeks of 2012 to sketch out a broad outline of higher tax revenue and reduced entitlement spending, kicking the can down the road, as it were, for next year's Congress to fill in the blanks with the necessary legislative details," said McManus. "Particularly with Congress needing to improve its low 'job-approval-rating' of 21 percent, the tremendous pressure to reach a compromise may serve as sufficient impetus for action."
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