Estate tax

Under The American Taxpayer Relief Act of 2012 (ATRA), the top estate tax rate will be 40%. This is a five percentage point increase over the 2012 rate, but significantly less than the 55% rate that was scheduled to return for 2013, and it’s still quite low historically. The estate tax exemption will continue to be an annually inflation-adjusted $5 million, so for 2013 it’s $5.25 million. This will provide significant tax savings over the $1 million exemption that had been scheduled to return for 2013.

ATRA also makes permanent exemption “portability” between spouses.

It’s important to review your estate plan in light of these changes. It’s possible the exemption and rate changes could have unintended consequences on your plan. A review will allow you to make the most of available exemptions and ensure your assets will be distributed according to your wishes.

Gift tax

Under ATRA, the gift tax continues to follow the estate tax exemption and rates. Any gift tax exemption used during life reduces the estate tax exemption available at death.

But keep in mind that for 2013 you can exclude certain gifts up to $14,000 per recipient each year ($28,000 per recipient if your spouse elects to split the gift with you or you’re giving community property) without using up any of your gift tax exemption. This reflects an inflation adjustment over the $13,000 annual exclusion that had applied for the last few years. (The exclusion increases only in $1,000 increments, so it typically goes up only every few years.)

GST tax

The generation-skipping transfer tax generally applies to transfers (both during life and at death) made to people two generations or more below you, such as your grandchildren. This is in addition to any gift or estate tax due.

Under ATRA, the GST tax also continues to follow the estate tax exemption, and the GST tax rate continues to be the same as the top estate tax rate. ATRA also preserved certain GST tax protections, including deemed and retroactive allocation of GST tax exemptions, relief for late allocations, and the ability to sever trusts for GST tax purposes. Disclaimer: Exemption portability between spouses doesn’t apply to the GST tax exemption.

State taxes

ATRA makes permanent the federal estate tax deduction (rather than a credit) for state estate taxes paid. Keep in mind that many states impose estate tax at a lower threshold than the federal government does. To avoid unexpected tax liability or other unintended consequences, it’s critical to consider state law.

Tax-smart giving

Giving away assets now will help you reduce the size of your taxable estate. Here are some additional strategies for tax-smart giving:

Choose gifts wisely. Consider both estate and income tax consequences and the economic aspects of any gifts you’d like to make:

  • To minimize estate tax, gift property with the greatest future appreciation potential.
  • To minimize your beneficiary’s income tax, gift property that hasn’t already appreciated significantly since you’ve owned it.
  • To minimize your own income tax, don’t gift property that’s declined in value. Instead, consider selling the property so you can take the tax loss and then gift the sale proceeds.

Plan gifts to grandchildren carefully. Annual exclusion gifts are generally exempt from the GST tax, so they also help you preserve your GST tax exemption for other transfers. For gifts that don’t qualify for the exclusion to be completely tax-free, you generally must apply both your GST tax exemption and your gift tax exemption.

So, for example, if you make an annual exclusion gift to your grandson and you want to give him an additional $30,000 in the same year to help him make a down payment on his first home, you’ll have to use $30,000 of your GST tax exemption plus $30,000 of your gift tax exemption to avoid any tax on the transfer.

Gift interests in your business. If you own a business, you can leverage your gift tax exclusions and exemption by gifting ownership interests, which may be eligible for valuation discounts. So, for example, if the discounts total 30%, in 2013 you can gift an ownership interest equal to as much as $20,000 tax-free because the discounted value doesn’t exceed the $14,000 annual exclusion. The IRS may challenge the value; a professional, independent valuation is strongly recommended.

Gift FLP interests. Another way to benefit from valuation discounts is to set up a family limited partnership. You fund the FLP and then gift limited partnership interests. The IRS is scrutinizing FLPs, so be sure to set up and operate yours properly.

Pay tuition and medical expenses. You may pay these expenses for a loved one without the payment being treated as a taxable gift, as long as the payment is made directly to the provider.

Make gifts to charity. Donations to qualified charities aren’t subject to gift taxes and may provide an income tax deduction.