Estate Planning Substantially Changed by the 2012 American Taxpayer Relief Act

The American Taxpayer Relief Act of 2012 may let you simplify your estate plan or do more tax planning, but you ignore it at your peril (or at least at the peril of your beneficiaries' pocketbooks).


By nearly every reckoning, Americans were pleased to see Congress arrive at an agreement to avoid the infamous "fiscal cliff" by passing the American Taxpayer Relief Act of 2012 (the "Act").  With respect to your estate planning issues, the Act offers you the opportunity to simplify your estate plans without facing higher estate taxes.

This article first summarizes the changes made that have an impact upon estate planning.  Those who have read about these changes previously may wish to skip to our summary of the "Planning Implications of the Act," below.

Principal ATRA Changes Related to Estate Planning

The Act includes a few provisions that directly affect transfer taxes:

  • Five million dollar exemption.  In lieu of the $1,000,000 exemption that would have taken effect, or the $3,500,000 exemption proposed by the Obama Administration, the negotiations resulted in retention of the full $5,000,000 exemption amount that had been temporary under prior law.  This exemption applies for estate, gift, and generation skipping transfer tax purposes.  That is, the portion of the exemption not utilized to off-set gift taxes will be available to apply against the estate tax.  Transfers that "skip" a generation, and would therefore be subject to the generation skipping transfer tax, in addition to the estate or gift tax, have an exemption in the same amount.
  • Indexing for Inflation.  For 2012, the "$5,000,000" exemption was actually $5,120,000 as a result of inflation adjustments.  The cost of living indexing feature was renewed, and the 2013 exemption is now $5,250,000.
  • Portability.  Also renewed is the ability of a surviving spouse, subject to limitations, to make use of the estate tax exemption not used by the predeceased spouse.
  • Increased Maximum Tax Rate.  The prior maximum tax rate on taxable estates was 35%.  This rate has been increased to 40%.

Income Tax Changes Affecting the Estate Plan

A number of changes in the federal income tax laws received significant attention in the media during the legislative process surrounding passage of the Act, but little attention was given to the impact that these changes may have on estate planning.  While many of the changes can influence planning decisions in any specific case, the most significant changes are the following:

  • Higher Marginal Income Tax Rates.  The top income tax rate has been increased from 35% to 39.6%, starting at $400,000 of single-taxpayer income ($450,000 for a joint return). Trusts and estates, however, hit this top rate at only $11,950.
  • Higher Capital Gain and Dividend Tax Rates.  The capital gain and dividend tax rates are now 20%, up from 15%, though some lower-income taxpayers are relieved of this tax entirely.
  • Itemized Deduction Phase-outs.  Itemized deductions are phased out for single taxpayers with income over $250,000 (joint returns over $300,000).
  • Medicare Tax on Investment Income.  Not a part of the Act, but taking effect January 1, 2013, is a 3.8% tax on investment income of taxpayers with income over $200,000 ($250,000 for married taxpayers).  For trusts and estates that have undistributed net investment income, the 2013 threshold for application of this surtax is only $11,950.

Planning Implications of The Act

The permanency of the higher exemption amounts will help reduce the tax burden for many taxpayers, and potentially simplify your estate planning.  Thus, even the most recent estate plans should be reviewed because they may be dramatically affected by the changes.  Here are a few of the more significant ways in which estate planning has been affected:

  • Income Tax/Estate Tax Tradeoffs.  For many years, estate planning has been driven, in part, by the income tax costs associated with some estate tax savings.  These are complex issues that vary from person to person based on several factors, including, but certainly not limited to, the value, nature, and income tax basis of specific property.  A number of aspects of the Act, including the permanency of the estate tax exemption amounts, increased income tax rates, and the Medicare surtax, have shifted the playing field substantially, and will change the optimal estate plan for many persons.
  • Further Transfers.  The indexing of the exemption amount to the cost of living, bringing it to a level $130,000 over the 2012 amount, will permit judicious additional transfer planning in 2013.  Careful attention should be paid, however, to the impact of the factors mentioned in this article, as alternative approaches may be advisable.
  • Irrevocable Trusts.  Estate planners endeavor to build into irrevocable trusts as much flexibility as possible, consistent with tax limitations and planning objectives.  The Act contains precisely the sort of changes that may warrant consideration of some of the options that may be available.  In fact, because of the 11th-hour (some would say 13th-hour) action by Congress, even trusts that were put in place in late 2012 should be reviewed in light of the final legislation.
  • Exemption-based Formula Clauses.  For over 30 years, estate planners have made use of terms in will and trust documents designed to self-adjust for changes in the estate tax exemption amount and its consumption through lifetime giving.  This approach has maximized tax savings and avoided frequent amendments to estate planning documents.  Given the permanency of the higher estate tax exemption amounts, however, many persons, perhaps including you, should consider the adoption of a different approach.  Your existing documents and updated asset information, are relevant to this analysis.  The good news is that such a review may result in simplification of your estate planning documents and estate plan.
  • Trust Income Tax Planning.  Trusts and estates have for some time been subject to extremely compressed income tax rate brackets, requiring careful attention to planning options.  However, the Act's higher marginal rates and low threshold for the Medicare surtax make this planning even more critical.
  • Planning Ahead For Potential Future Changes.  Although the exemption amounts and rates mentioned above are as "permanent" as tax laws get, the story is not over.  Deficit reduction proposals targeted at what are labeled "loopholes" have been proposed for some time.  The Obama Administration has promoted such items in deficit negotiations.  These include modifications to the rules affecting family limited partnerships (and LLCs), Grantor Retained Annuity Trusts, Grantor Trusts, and other planning options.  Estate planners often use these tools to restructure family businesses, establish family investment funds, and address tax issues facing clients with substantial net worth.  Because of potential new changes, planning may be very time sensitive to take advantage of "grandfathering" dates that could apply to such changes.

Review Needed

No crystal ball was available to predict the legislative changes Congress ultimately adopted in the Act. Although pre-Act planning was designed to eliminate the risks of some possible results, much of that planning included features designed to accommodate adjustment or modification.  Now that the fundamental elements of the new tax structure are known, it is appropriate for you to review your estate plan in light of those elements.  If you would benefit from additional advanced planning for businesses and investments, prompt action may be in order.

© 2017 Ward and Smith, P.A. For further information regarding the issues described above, please contact Eldridge D. Dodson or Michael L. Miller.

This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.

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