So the fiscal cliff has been averted. If for no other reason, I’m happy it’s been resolved so I can stop hearing about the fiscal cliff. But what do the changes to our tax laws mean to you and me with respect to estate and gift tax?
A few weeks ago, I predicted that Congress would resolve the estate tax aspect of the fiscal cliff by retaining the current exemption equivalent against the estate tax, that is, $5,000,000. Though it doesn’t happen all the time, this time, my prediction was correct.
Congress retained the $5,000,000 exemption equivalent against the federal estate tax. Since the exemption equivalent is indexed for inflation, the current exemption equivalent is $5,250,000.
What this means is, an individual would have to die with more than $5,250,000 before his estate will pay federal estate tax. Since most people don’t have $5,250,000, the federal estate tax is a complete non-issue for the vast majority of Americans. In fact, there are so few estates that paid estate tax last year that the only thing that amazes me about the federal estate tax is the number of people who worry about it.
A married couple can shelter $10,500,000 from estate tax. The federal law makes it easier for a married couple to use both spouses’ exemption equivalent, a concept called “portability.” The second-to-die spouse can claim the unused portion of the first-to-die spouse’s exemption equivalent, but in order to make the claim, the second-to-die spouse must file a federal estate tax return upon the death of the first spouse. (I said “easier,” not easy. Legal work would still be necessary.)
Congress did raise the estate tax rate from 35% to 40%; however, since most of our estates will never come close to paying estate tax, the rate of the tax is hardly a concern.
Notice that I say most of our estate will never pay federal estate tax. Since the individual exemption equivalent is $5,250,000 and the exemption equivalent for a married couple is $10,500,000, I think we can all agree that my statement is accurate, but I want you to take notice of the limitation of the statement.
While most of our estates will not have to pay federal estate tax, a great many of my clients are affected, and will continue to be affected, by the New Jersey estate tax. In 2001, the federal government began to increase sharply the exemption equivalent against federal estate, raising it from $675,000 to its current lofty height of $5,250,000.
When the federal government made this change to the law, the state of New Jersey reacted by freezing the credit against New Jersey estate tax at $675,000. So, in New Jersey, if your estate exceeds $675,000, your estate is affected by New Jersey estate tax. Also, unlike the federal law, the state law does not contain a portability feature.
From a practical standpoint, what this means is that many married couples will continue to need credit shelter trust planning. Simply stated, a credit shelter trust is a trust that is typically contained in the last wills and testaments of a married couple. The trusts permit the couple to take advantage of each spouse’s $675,000 credit against New Jersey estate tax. By using credit shelter trusts, a married couple can shelter $1,350,000 from New Jersey estate tax, which is $675,000 times two.
The federal government also retained the $5,000,000 lifetime credit against gift tax. Since this credit is also indexed for inflation, an individual can make lifetime gifts up to $5,250,000 without paying federal gift tax. (The state of New Jersey does not impose a gift tax.)
The annual exclusion amount, which is also indexed for inflation, increased from $13,000 to $14,000. Taken together, the lifetime gift credit and the annual exclusion credit means that an individual can gift $14,000 each and every year to an unlimited number of people without reducing his $5,250,000 lifetime credit and because of his lifetime credit, he can gift an additional $5,250,000 without ever having to worry about gift tax.
So, do most of us have to worry about federal estate tax or gift tax? No. You are now free to worry about something else.
Even when federal estate tax is not a concern, other factors can influence how assets are handled. A broader approach can help avoid overlooked issues.