On January 1, 3013, President Obama signed into law the American Taxpayer Relief Act of 2012 known as the “Fiscal Cliff Deal.” The Fiscal Cliff Deal touches many areas of federal tax law. Here are the nuts and bolts on how the Fiscal Cliff Deal affects federal gift and estate taxes.

Who will be required to pay federal estate tax?

The new tax law imposes federal estate taxes on individuals who die with a net worth greater than the “basic exclusion amount,” which is adjusted for inflation every year.  On January 11, 2013 the IRS announced that the basic exclusion amount for individuals dying in 2013 is $5.25 million. Any amount above the basic exclusion amount may potentially be taxed as high as 40%.

Note: Although an individual that dies in 2013 with a net worth of less than $5.25 million will not be required to pay any federal estate taxes, the estate may still be subject to state estate taxes. In New York, the exclusion amount is only $1 million per person. Any amount over the state exclusion amount may potentially be taxed as high as 16%.

Do spouses have to pay estate taxes when they inherit from each other?

All assets left to a surviving spouse are not subject to estate taxes. This is known as the “marital deduction.”

Note: The marital deduction applies only if the inheriting spouse is a U.S. citizen.

How much can the surviving spouse pass free of estate taxes?

The Fiscal Cliff Deal made the concept of “portability” permanent.  The surviving spouse can increase his or her basic exclusion amount by any unused amounts of the first deceased spouse’s basic exclusion. This enables a married couple to transfer up to $10.5 million free of estate taxes.

Note:  Portability is not automatic.  An estate tax return will need to be filed when the first spouse dies, even if no tax is owed. The tax return is due within nine months after death with a permissible six-month extension.  If an estate tax return is not filed or the deadline is missed, the surviving spouse loses the right to portability of the unused portion of the deceased spouse’s basic exclusion.

What happens to portability with a remarriage?

It depends on who dies first.

For example, Robert died in 2013 and used his entire basic exclusion amount except $1 million (i.e. he left $4.25 million to his children outright). His widow, Lisa, has a $5.25 million exemption amount of her own. As the executor of Robert’s estate, Lisa files an estate tax return, transferring Robert’s unused exemption to her, so that she will then be able to pass $6.25 million tax-free (her own $5.25 million exemption plus Robert’s $1 million unused exemption).

Lisa gets remarried to Peter. If Peter dies before Lisa, she can no longer use Robert’s unused exemption amount – only Peter’s. If Peter’s unused basic exemption amount is less than Robert’s, Lisa is out of luck.

On the other hand, if Lisa dies first, the situation is different. She came into the marriage with a $6.25 million exemption amount, including the $1 million unused exemption from Robert. Let’s assume that she leaves $4 million to the children she and Robert had together. In that case, Peter can use the remaining $2.25 million exemption, along with his own.

Note: Under the new tax law the unused basic exclusion amount carried over to any spouse (even a second spouse) can never be more than $5.25 million.

How does the Fiscal Cliff Deal affect lifetime gifts?

On the federal level, estates and lifetime gifts are taxed as  if they are one and the same. The basic exclusion amount (currently $5.25 million per person) applies to estates and lifetime gifts collectively, and is referred to many times as the “unified credit.”

The IRS expects you to report lifetime gifts so it will know how much of the basic exclusion amount has already been used up when you die. For example, if you have used $2 million of the basic exclusion amount by making lifetime gifts, the unused basic exclusion amount for your estate if you die in 2013 will be $3.25 million, rather than $5.25 million.

Note:  New York does not impose a gift tax. Therefore, a New York resident with $2 million in assets could make a lifetime gift of $1 million (and file a federal gift tax return) without incurring any federal or state taxes. When the person dies (with only $1 million in assets left in his estate), no federal or state estate taxes will be due either.

Are there lifetime gifts that don’t count as part of the basic exclusion amount?

Yes.  A person is allowed to give $14,000 per year without it counting against the basic exclusion amount. This is known as the “annual exclusion.” The annual exclusion is per donee. For example, Joey has three children – Sara, Jack and Freddy. Joey can give $14,000 to each of Sara, Jack and Freddy without triggering his $5.25 million basic exclusion amount.

Note:  Spouses can combine the annual exclusion to double the size of the gift. This is called “split gifting.” For example, if Joey is married to Rachel, Joey and Rachel can give each of their children a total of $28,000 annually without using any amount from each of their $5.25 million basic exclusion amount

Conclusion:

Many people would rather spend more time planning for their vacations rather than plan for their estates even though estate planning is much more important. Without a comprehensive estate plan, a significant part of the work you’ve done throughout your life, both at your job and with your investments, may be lost to federal and state estate taxes.

The Trusts & Estates Practice Group at Yedid & Zeitoune, PLLC work closely with each client’s needs to put together the best possible estate plan, taking into account all favorable tax treatments allowable for the situation at hand. Let us help you prepare for you and your family’s future.

The attorneys in the Trust & Estates Practice Group at Yedid & Zeitoune have a combined 15 years of legal experience and are ready to assist you with all your estate planning needs.

Isaac Yedid, Esq. and Raymond Zeitoune, Esq.

Yedid & Zeitoune, PLLC 

1172 Coney Island Avenue Brooklyn, New York 11230

Phone: (347) 461-9800 Fax: (718) 421-1695 Email: [email protected]

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