To Our Friends and Colleagues:

On January 2, 2013, President Obama signed the American Taxpayer Relief Act of 2012 (the “Act”). The Act permanently extends the Bush era tax rates for the vast majority of taxpayers while increasing tax rates for individuals with taxable income above statutory thresholds. Specifically, the Act increases the tax rate for ordinary income for affected individuals to 39.6% and increases the tax rate for net long-term capital gains and qualified dividend income for these taxpayers to 20%. In addition, the Act makes changes to estate and gift tax rules and extends a number of popular tax provisions that otherwise would have expired.  In the balance of this writing, we will discuss some of the most significant portions of the Act that pertain to the income, estate and trust laws.



The top income tax rate is increased to 39.6% from 35%, applicable to married taxpayers with taxable income in excess of $450,000, heads of household with taxable income in excess of $425,000 and single taxpayers with taxable income in excess of $400,000 (with each of these thresholds subject to inflation adjustment in the future). For estate and trust income taxes, the top tax rate is also 39.6%, applicable to estates and trusts earning more than approximately $12,000 of income.  In addition, taxpayers subject to the 39.6% income tax rate will be subject to a 20% tax rate on both long-term capital gains and qualified dividends (increased from 15% in 2012).  These increased income tax rates are in addition to the 3.8% Medicare surtax on investment income previously enacted as part of the Health Care and Education Reconciliation Act of 2010.  The 3.8% surtax is applicable to married taxpayers with a modified adjusted gross income in excess of $250,000 and single and heads of household taxpayers with modified adjusted gross income in excess of $200,000.  Therefore, the top tax rate for long-term capital gains and qualified dividends can now be as high as 23.8% for high-income taxpayers.

In addition to the increased income tax rates, the limitations on itemized deductions and personal exemptions that expired three years ago have been reinstated. Married taxpayers earning more than the "applicable threshold" of $300,000 (or $275,000 for heads of household and $250,000 for single taxpayers) will have itemized deductions reduced by 3% of their adjusted gross income in excess of the applicable threshold (up to a maximum reduction of 80% of their itemized deductions). Again, the income thresholds will be adjusted for inflation in future years.



The IRA charitable rollover (permitting direct distributions from an IRA to a qualified charity be excluded from income and count as part of the required minimum distribution) has been extended to apply to IRA distributions made in 2012 and 2013. Because of the late enactment, special provisions are included to permit 2012 income rollover treatment for distributions made before February 1 (including withdrawals made in December 2012 that were subsequently transferred to a charity during January 2013).



The tax rate for estate, gift and generation-skipping transfer taxes is increased from 35% to 40%. The exemption for all three taxes continues to be $5,000,000 adjusted for inflation. The actual exemption for 2013 is $5,250,000, an increase from the $5,120,000 exemption in effect for 2012.  In addition, although not impacted by the Act, the gift tax annual exclusion is $14,000 for 2013.

The Act also makes “permanent” the concept of portability.  By way of background, until 2010, if an individual died and failed to utilize all of his or her gift and estate tax exemption, this exemption was forever lost.  Under portability, a surviving spouse will be able to utilize the unused exemption of his or her deceased spouse for lifetime gifts or transfers at death.  Notwithstanding portability, it is still generally more advantageous to plan for the funding of a so-called credit shelter trust upon the death of the first spouse. 

Portability must be affirmatively elected, meaning that the deceased spouse’s executor must make a portability election on the deceased spouse’s estate tax return, signifying that the surviving spouse may utilize the deceased spouse’s unused estate tax exemption.  Accordingly, to benefit from portability, the deceased spouse’s estate must file a federal estate tax return even if such a return would not otherwise be required because the value of the estate did not exceed the $5,000,000+ exemption amount.  It is important to note, however, that portability does not apply to state estate tax (the New Jersey estate tax exemption remains $675,000) or the generation-skipping tax. 



Except for the IRA charitable rollover provision, all the provisions mentioned above are permanent changes to the tax code. Although "permanent" changes are not exempt from future legislative action, the threat of "sunset" provisions looming over the past decade has passed, and thus these changes offer a measure of stability for planning purposes.

The coming months will bring additional budget battles in Washington, and some previously proposed limitations on grantor-retained annuity trusts and restrictions on valuation discounts may once again surface as the President and Congress look for new sources of revenue.  Until such measures become law, however, the current planning environment, including historically low interest rates, continue to offer many attractive options for those interested in making gifts.  Even those who previously used all of their gift tax exemption now have an additional $130,000 gift tax exemption available in 2013 with even more gift exemption expected in future years as a result of the continuing inflation adjustments.

Finally, for taxpayers who structured estate plans when the estate tax exemption was significantly lower (2009 and before), the $5,250,000 exemption (which will continue to grow through annual inflation adjustments) may create a disconnect with the taxpayer’s initial intent or create a state estate tax at the death of the first spouse which could, and perhaps should, otherwise be avoided.  Accordingly, now may be a good time for a thorough review of an existing estate plan.