Congress finally acted to create some stability in the estate planning law by making permanent the $5,000,000 exemption for an individual’s estate. This exemption is indexed for inflation and the gift tax exemption remains at the same amount. In Maryland, the estate tax exemption still stands at $1,000,000. Families with estate assets exceeding $1,000.000 should use bypass trusts to minimize the Maryland estate tax. The benefits of trust planning for non-tax reasons may justify trusts for smaller estates. The other part of the American Taxpayer Relief Act of 2012 is higher tax rates especially on capital gains. For higher income tax payers the rate can approach 25% with the 20% rate + 3.8% Medicare Surcharge + the phase out of exemptions. The top tax income tax rate is now 39.6% which also applies to trust income at level of approximately $12,000 per year.
What do all these changes mean to the average individual? Individuals can now plan with some certainty, but there is no standard plan for everyone. First, everyone must look to their family needs and plan accordingly. Second, the tax consequences of the plan must balance the advantages of stepped up basis upon death against taking gains now and reducing estate taxes. Gifts to irrevocable trusts can avoid Maryland Estate tax and ensure exemption from Federal Estate Taxes. However, a trust will receive the original basis of the gift rather than receiving stepped up basis at death or an exemption in case of a house. Third, the structure of the trust can affect whether the trust income is subject to trust income tax rates or is passed to the beneficiary on a K-1 to be taxed at individual rates.
Finally, these “permanent” tax changes will stand only as long as Congress decides that more revenue could be gained by implementing some of the Obama “Green Book” items such as eliminating the exclusion for grantor trusts which could affect many life insurance trusts and limiting the length of dynasty trusts to 90 years. In conclusion, the American Taxpayer Relief Act of 2012 requires an estate plan to balance family needs with both estate and income tax consequences. Based on Congress’ past reluctance to deal with tax issues the legislation is likely to be permanent for the foreseeable future. Good estate plans will need to be tailored to family needs first and then adjusted to minimize tax consequences.