After the cliff: Q&A on estate and gift taxes

Since the fiscal cliff was averted, there has been widespread confusion about the effect on estate planning under the tax law passed by Congress. In short, Congress made permanent the system that has been in effect for the past two years.

That was an important achievement: Without any action on their part, the tax-free amount would have automatically reverted to $1 million per person, and the rate for most estates would have gone up to 55%. But at the end of the day, the only thing lawmakers actually changed was the gift and estate tax rate, which has gone up to a top rate of 40% (it was 35% before 2013).

Here are six frequently asked questions about the federal estate tax in the wake of the fiscal cliff deal.

1. Who has to pay federal estate tax? Once you’re worth more than a certain amount, taxes shrink your estate. Under current tax law, for 2012 we can each transfer up to $5.12 million tax-free during life or at death. That figure is called the basic exclusion amount, and it is adjusted for inflation. More good news for Wisconsin residents – there continues to be NO Wisconsin estate tax!

2. Do spouses have to pay the tax when they inherit from each other? The new law doesn’t change this either. There is an UNLIMITED deduction (aka “the marital deduction”) from estate and gift taxes that postpones the tax on assets inherited from a spouse until the second spouse dies.

3. How much can the second spouse pass tax-free? Here’s where things get a bit complicated – but in a good way. The 2010 tax law gave married couples a wonderful tax break, which the new law has made permanent. Widows and widowers can add any unused exclusion of the spouse who died most recently to their own. This “portability” feature under the estate rules enables a couple to transfer up to $10.24 million tax-free. Still, portability is not automatic. Even if no estate tax is due, an estate return must still be filed to elect to claim the unused exclusion to be transferred to the surviving spouse.


4. How does this relate to lifetime gifts? The lifetime gift tax exclusion and the estate tax exclusion are expressed as a total amount – currently $5.12 million per person – and it is possible to use this exclusion (sometimes called the “unified credit”) to transfer assets during life, after death, or a combination of the two. If you exceed the limit, you (or your heirs) will owe tax of up to 40%.

5. How do lifetime reportable gifts interact with the estate tax? The IRS expects taxpayers to keep a running tally and report taxable gifts so it will know how much has already been used up when individuals die. For example, if you have used $1 million of the exclusion to make taxable lifetime gifts, the unused exclusion when you die will be $4.12 million rather than $5.12 million.

6. Are there lifetime gifts that don’t count? Absolutely, and this is a common source of confusion. Beginning in 2013, individuals can each give another person (related persons or unrelated persons) $14,000 per year without it counting against the lifetime exemption. For example, this year, relying on the annual exclusion, a married couple with a child who is married and has two children could make a joint cash gift of $28,000 to the adult child, the child’s spouse, and each grandchild – four people – providing the family with $112,000 a year. Only gifts that exceed the limit count against the lifetime exclusion.

Make sure your current will and estate plan conform to the new “permanent” estate and gift tax rules.

Mike Scholz is a partner at Wegner CPAs.