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The President’s Proposed Budget And Changes To Estate And Gift Taxes

As the “fiscal cliff” approached at the end of 2012, estate planning attorneys faced the threat that many of their clients would suddenly go from being exempt from estate and gift taxes to being subjected to a large, 55% tax on most of their estate.  Attorneys used the last few months of 2012 to promote gifting programs to shift assets out of clients’ estates and avoid this tax.  When the fiscal cliff finally arrived, Congress passed a last-minute bill to extend the tax cuts and to avoid having the estate and gift tax revert to levels prior to the Bush Tax Cut era.  Now, with the fiscal cliff well behind us, the President has proposed a 2014 budget which would drastically change the estate and gift tax, as well as several other important aspects of estate planning and tax avoidance.  This budget will be scrutinized and debated, but may ultimately result in a major overhaul to the estate and gift tax.

Estate Tax Changes:

In his budget, the President calls for the estate tax to revert to 2009 levels.  Under those parameters, the first $3.5 million of one’s estate would be tax-exempt and the portion above that would face a top tax rate of 45%. This means that married couples would still be able to use estate planning techniques to exclude the first $7 million of their estate, but this nonetheless shifts many clients into the category of being subject to taxation.  Going forward, the budget doesn’t state that the estate tax exemption amount will be indexed for inflation, so a person’s lifetime exemption would remain at $3.5 million until some other change is made. This means that down the road as inflation increases the amount of money taxpayers may place in their estates, a greater number of smaller estates would also be subject to the estate tax rate.

The budget also calls for a step-down in basis for assets that have a lower fair market value at the time of a person’s death than his or her basis.  The law would impose a duty for the executor or personal representative of a person’s to report to the IRS and to the recipient of the assets what the person’s basis was the time of his or her death.    The basis of property in the hands of the recipient could be no greater than the value of that property as determined for estate or gift tax purposes.

Gift Tax Changes:

In addition to scaling back the estate tax to 2009 levels, the President’s budget would return the gift tax to these levels.  This means that a person’s lifetime exclusion amount for gifts would be returned to $1 million.  This legislation would limit an estate planning attorney’s ability to utilize gifting techniques to remove assets from an estate, and would encourage individuals to retain assets until their death to take advantage of the larger exclusion.

New Limits on Retirement Accounts:

The new budget proposes to place a cap on the amount a person can hold in his or her individual retirement accounts.  The value of defined contribution plans like 401(k) and IRA accounts, as well as defined benefit pensions, would count toward the limit.  The measurement for the amount of the cap would be the amount needed to fund a $205,000 annual annuity for a 62-year-old, indexed for inflation, which currently amounts to a $3.4 million limitation.  This would affect less than 1% of individual retirement accounts in 2014, but it would be a step in the direction of the federal government beginning to scale back the tax benefits associated with these retirement accounts. 

Other Miscellaneous Changes:

  • Generation Skipping Tax tax-exempt dynasty trusts will now have a maximum life of 90 years.
  • Grantor Retained Annuity Trusts (GRATs) will be required to have a minimum trust term of ten years.
  • Intentionally Defective Grantor Trusts will no longer be effective and gift tax will be imposed upon the entire value of the amount distributed from the trust.

Although this budget is still subject to change and debate, it shows the direction in which the country is likely headed with regard to the future of the estate and gift tax.

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