How about a little 'me time': estate planning after ATRA.

• Author: Siegler, Doug
• Position: American Taxpayer Relief Act of 2012

The American Taxpayer Relief Act of 2012 ("ATRA') signed into law by President Obama on January 2, 2013, brings to an end more than a decade of uncertainty for estate planners and their clients. Although nothing in the Internal Revenue Code can be said to be permanent--especially in light of the never-ending search for revenue--ATRA provides a degree of certainty in the basic rules of estate, gift, and generation-skipping transfer tax planning.

Recent History

The transfer tax system set out in the Internal Revenue Code consists of three separate taxes governing the transmission of property during life and at death:

* The gift tax, imposed on gratuitous transfers made during life;

* The estate tax, imposed on the transfer of property at death; and

* The generation-skipping transfer ("GST") tax, imposed on certain transfers during life and at death to or for the benefit of grandchildren and more remote descendants.

Prior to the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), the estate and gift taxes were computed on a single rate schedule, beginning at 18% and increasing to 55% on cumulative taxable gifts and taxable estates of $3,000,000. A "unified credit" was available against the gift and estate taxes that shielded from tax the first $675,000 of cumulative taxable gifts or of a decedent's taxable estate. Under pre-EGTRRA law, the unified credit was scheduled to increase, shielding $1,000,000 by 2006. Also under pre-EGTRRA law, the income tax basis of property owned by a decedent at death was adjusted to its date-of-death value, thereby eliminating all pre-death appreciation. By contrast, the recipient of a lifetime gift generally received the donor's cost basis in the gifted property in determining any gains recognized on a subsequent sale of the property.

The GST tax is a flat tax imposed at the highest marginal estate tax rate in effect at the time the generation-skipping transfer occurs; therefore, prior to EGTRRA, the GST tax was imposed at a flat 55% rate. Each person had a cumulative $1,000,000 exemption against the GST tax, which could be applied to lifetime gifts or to property passing at death, to prevent application of the tax to the transferred property. Commencing in 1998, the GST exemption was indexed for inflation, and had a value of $1,060,000 in 2001.

EGTRRA dramatically changed these rates and exemptions by--

* Beginning in 2002, incrementally reducing the top estate and gift tax rates from 55%, reaching 45% for gifts made in 2009 and for the estates of decedents dying in 2009;

* Immediately increasing the gift tax unified credit equivalent to $1,000,000;

* Immediately increasing the estate tax unified credit equivalent to $1,000,000, and providing for the incremental increase in the exemption, culminating in a $3,500,000 exemption for persons dying in 2009;

* Commencing in 2004, linking the available GST exemption to the amount of the estate tax exemption, with the result that the GST exemption which would reach $3,500,000 for transfers occurring in 2009;

* Providing for a one-year "holiday" from the imposition of the estate and GST taxes (but not the gift taxes) for persons dying in, and GSTs occurring in, 2010;

* Eliminating the income tax basis adjustment for property owned by decedents dying in 2010, and replacing it with a complex, modified carry-over basis regime applicable to decedents dying in 2010; and

* Reinstating the pre-EGTRRA law for 2011 and thereafter.

Thus, EGTRRA increased exemptions and decreased tax rates--all good changes to be sure--but at a serious cost: the introduction of uncertainty as to the long-term structure of the transfer tax. The built-in sunset of the EGTRRA changes, leading to a one-year "holiday" in 2010 for the estate and GST taxes but not the gift tax, followed by reinstatement of pre-EGTRRA law in 2011 and thereafter, created a decade of complexity and uncertainty, making long-term estate planning decisions difficult.

Following the enactment of EGTRRA, legislation was periodically introduced seeking to either make the one-year repeal of the estate and GST taxes in 2010 permanent or to lock in a set of transfer tax rates and exemptions in order to avoid the 2010 repeal. Perhaps not surprisingly, Congress waited until the last minute--December of 2010--to take action.

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the "2010 Act") implemented a Solomon-like solution to the 2010 repeal of the estate and GST taxes, and made substantial changes to the transfer tax system. Specifically, the 2010 Act--

* Provided the estates of persons dying in 2010 with a choice between (a) imposition of Federal estate tax, but with a $5,000,000 exemption and a top rate of 35%, along with a cost basis adjustment for estate assets; or (b) opting out of the estate tax, but allowing only a limited cost basis adjustment for assets owned by the decedent.

* Reenacted the GST tax for transfers made in 2010, but subjected the transfers to a tax rate of zero percent in 2010.

* Re-unified the estate and gift exemptions, setting the exemption equivalent for both taxes at $5,000,000, and, commencing in 2011, indexing the exemption equivalent for inflation.

* Set the GST exemption at $5,000,000, and indexing that figure for inflation commencing in 2011.

* Decreased the top transfer tax rate from 45% to 35%.

* Provided that all these changes would sunset after 2012.

Thus, while the 2010 Act generously increased the estate, gift, and GST exemptions, substantially decreased the top tax rates, and re-unified the estate and gift tax regimes, the legislation effectively "kicked the can down the road," leaving practitioners and their clients to determine whether the law would once again revert to its 2001 rates and exemptions at the end of 2012.

In addition to these changes, the 2010 Act enacted "spousal portability" of the estate tax exemption. Portability, which will be discussed in more detail below, basically provides that if the first spouse to die in a married couple (the "predeceased spouse") fails to fully utilize his estate tax exemption--because the value of the estate is below the exemption threshold or because deductible bequests to a surviving spouse or to charity allow the decedent spouse's estate tax liability to be eliminated without exhausting his exemption, the surviving spouse can now claim the unused exemption, add it to her available exemption, and apply the total amount against lifetime gifts or against the estate tax imposed at her subsequent death.

Pre-ATRA Panic

With 2012 being an election year, it should have come as no surprise that Congress and the President failed to take action before November to determine the fate of the expiring provisions of the 2010 Act, including the estate, gift, and GST taxes. Estate planners and their clients were forced to assume that the favorable tax rates and exemptions included in the 2010 Act would, in the worst case, expire, causing the pre-EGTRRA law, with its substantially higher rates and lower exemptions, to be reenacted. Even a compromise, such as the reenactment of the pre-2010 Act estate and GST exemption levels of $3,500,000 and a top transfer tax rate of 45%, would have amounted to a significant increase in transfer tax exposure for many taxpayers. In either case, the strong possibility of a more expensive transfer tax regime forced an unprecedented level of gift-giving activity in the second half of 2012, as clients raced to take advantage of the benefits of the $5,000,000 exemption and the 35% top rate.

ATRA Arrives

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