FILE --Attorney Leiha Macauley, a partner at the law firm Day Pitney, at her office in Boston, Nov. 11, 2010. For estate and gift taxes, all but the richest of the rich will probably be able to protect their holdings from taxes in the tax deal struck between the president and Congress to avoid the fiscal cliff.

Matthew Cavanaugh, Nyt - Nyt

FILE -- Richard Behrendt, first vice president and senior estate planner at Robert W. Baird & Company, at the company's offices in Milwaukee, Aug. 27, 2010. For estate and gift taxes, all but the richest of the rich will probably be able to protect their holdings from taxes in the tax deal struck between the president and Congress to avoid the fiscal cliff.

Erol Reyal, New York Times

A decade of uncertainty over gift, estate taxes ends

  • Article by: PAUL SULLIVAN
  • New York Times
  • January 12, 2013 - 9:16 PM

For many of the wealthy, the American Taxpayer Relief Act, passed this month by Congress, is aptly named.

All but the richest of the rich will probably be able to protect their holdings from federal estate and gift taxes now that Congress has permanently set the estate and gift tax exemptions at $5 million (a level that will rise with inflation).

"You could say this eliminates the estate tax for 99 percent of the population, though I've seen figures that say 99.7 or 99.8," said Richard Behrendt, director of estate planning at the financial services firm Baird and a former inspector for the Internal Revenue Service.

And while Congress also agreed to increase tax rates on dividends and capital gains from 15 to 20 percent for top earners -- in addition to the 3.8 percent Medicare surcharge on such earnings -- the rates are still far lower than those on their ordinary income. For the earners at the very top, whose income comes mostly from their portfolios of investments and not a paycheck like most of the rest of us, this is a good deal.

The estate tax, once an arcane assessment, has been in flux and attracting significant attention since 2001. That was when the exemption per person for the estate tax began to rise gradually from $675,000, with a 55 percent tax for anything above that amount, to $3.5 million in 2009 with a 45 percent rate for larger estates.

Then in 2010 the estate tax disappeared. Congress and President Obama could not reach an agreement on the tax. So that year, for the first time since 1916, Americans who died were not subject to a federal estate tax. (Their estates still paid state estate taxes, where they existed, and other taxes, including capital gains, on the value of the assets transferred.)

At the end of 2010, Obama and House Speaker John Boehner reached an agreement that was just as unlikely as the estate tax expiring in the first place: The new exemption was $5 million, indexed to inflation, with a 35 percent tax rate on any amount over that, and it would last for two years. The taxes and exemptions for gifts made during someone's lifetime to children and grandchildren were also raised to the same level, from $1 million and a 55 percent tax above that.

This was a far better rate and exemption than anyone expected. It also created a deadline of Dec. 31, 2012, for people who could make a major gift up to the exemption level.

Using the gift exemption was enticing because it meant those assets would appreciate outside of the estate of the person making the gift. Even paying the tax became attractive to the very rich because of how estate and gift taxes are levied. Take, for example, someone who has used up his exemption and wants to give an heir $1 million. The amount it would take to accomplish this differs depending on when it is given. In life, it would cost $1.4 million because the 40 percent gift tax is paid like a sales tax. If it was given after death, the estate would have to set aside about $1.65 million after the 40 percent estate tax was deducted.

As of this month, the estate and gift tax exemptions are permanently set at the same $5 million level, indexed for inflation, and the tax rate above that exemption is 40 percent, up from 35 percent. With indexing, the exemption is already about $5.25 million per person -- double for a couple -- and it will rise at a rate that means most Americans will continue to avoid paying any federal estate tax.

State concerns

"The new law yields a lot of clarity," said Dan Kesten, a law partner at Davis & Gilbert. "We can educate our clients more, and it will be easier for them to make decisions."

Kesten added: "For less wealthy people, they may not need much estate planning. I think we're back to the days of more straightforward wills and not much need for lifetime wealth transfers."

Still, there are a few unresolved issues.

While federal estate taxes will not hit most of the affluent anymore, state estate taxes can be a big concern. While only Connecticut has a state tax on gifts, about 20 states have estate taxes with much lower exemptions than the federal tax. In New Jersey, for example, the exemption is $675,000. In Minnesota, New York and Massachusetts, it is $1 million.

Many people may plan to retire to states like Florida that have no state estate tax. But as Leiha Macauley, head of the Boston office of the Day Pitney law firm, pointed out, you can't always plan when you will die.

She said one way to deal with this is to set up trusts that preserve each spouse's state exemption level. These are the same types of trusts that spouses created to take advantage of the federal exemption before this law made permanent the ability for a spouse to use a deceased spouse's exemptions. (This is what is known as portability.)

On the positive side for the affluent, a separate gift exemption known as the annual exclusion has also been indexed for inflation. It is $14,000 this year, up from $13,000 last year. It is set to rise every few years in $1,000 increments.

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