“Fiscal Cliff” Legislation Sets $5 Million Federal Estate Tax Exemption, Among Other Taxes

The so-called “fiscal cliff” legislation enacted earlier in January by Congress made a number of significant changes to our (whose? USA and/or NJ) tax laws. The new law, entitled “The American Taxpayer Relief Act”, restored the 39.6% Clinton-era income tax rate for high-income households, increased the capital gains tax rate to 20%, and extended Unemployment Insurance benefits for one year, among other things.

The “fiscal cliff” bill also made significant changes to the estate tax code. Here is a summary of the estate and gift tax components of this tax legislation:

  • Many provisions in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” that was passed two years ago, have now been made permanent. The new tax law sets the federal estate tax exemption level at $5 million per person and $10 million per couple. This means that a married couple, with appropriate estate tax planning, can shelter $10 million from any federal estate taxes. Additionally, the law is indexed for inflation, so the estate tax exemption amount will increase each year.
  • The gift tax and generation-skipping transfer tax exemptions established under the 2010 tax law have been continued, which means that the $5.12 million exemption for 2013 applies to gift and generation skipping tax transfers.
  • The estate and gift tax laws continue to be “unified” under the new law, which means that the $5 million per person estate tax exemption could be used to offset taxes due on lifetime gifts and/or bequests.
  • The new law raises the tax rate on estates that are valued above the $5 million per person exemption amount from 35 percent to 40 percent.
  • “Portability” of unused estate tax exemption remains an option under the new tax law. That is, the new law continues the option under the prior estate tax law for the executor of a deceased spouse’s estate to transfer any of the $5 million tax exemption that was not used after the death of the first spouse to the surviving spouse.  For example, if the first spouse left an estate of $2 million, then the surviving spouse could use the remaining $3 million that the first spouse did not use, plus the second spouse’s exemption of $5 million, to exempt a total of $8 million.

In light of the new tax legislation, the federal estate tax has become irrelevant for over 99% of estates, according to estimates from data compiled by the Internal Revenue Service. For the wealthiest individuals whose net worth exceeds $5 million, federal estate tax planning is certainly important given the high 40% estate tax rate.

Additionally, in New Jersey, we have a State estate tax for estates above the $675,000 exemption. Clearly, this low State estate tax exemption means that many more New Jersey residents will be subjected to the New Jersey estate tax than the federal estate tax. The tax rate for the New Jersey estate tax is not a fixed rate, unlike the federal estate tax rate, but the rate averages about 10%, which, of course, is much lower than the 40% federal estate tax rate.

In summary, while the new federal estate tax law will result in more estates that escape that tax, many estates still will be subjected to state estate and/or inheritance taxes, like in New Jersey. It remains important to consult with an estate planning attorney to consider planning strategies to minimize or eliminate estate and inheritance taxes.