In early 2013, Congress enacted legislation changing the federal estate tax yet again. Although the provisions of the tax are important (and are summarized below), the most significant aspect of the new tax law might be that it does not contain an expiration date.
Estate planning attorneys are all too familiar with the uncertainty caused by the fact that the 2001 tax law expired in 2010, and the 2010 tax law expired in 2012. Because the current tax law has no expiration date, some have referred to it as “permanent.” Technically speaking, no tax law is permanent, because Congress can change the law at any time. Nevertheless, the lack of an expiration date means that Congress may have little incentive to revisit the estate tax in the future.
This return to certainty is welcomed by estate planning attorneys, especially given that the federal estate tax has changed every year since 2008. In 2008, the federal estate tax exemption was $2,000,000, and the estate tax rate was 45 percent. In 2009, the exemption increased to $3,500,000. In 2010, the year began without an estate tax, but Congress brought back the tax on December 17 and made the tax retroactive to all of 2010. Estates of decedents dying in 2010 could choose either the law in effect at the beginning of 2010 or the law in effect at the end of 2010. At the beginning of 2010, there was no estate tax, but there also was no automatic step up in basis for income tax purposes. At the end of 2010, there was an estate tax with a $5,000,000 exemption and 35 percent rate, and the automatic step up in basis was restored. In 2011, there was no choice, and the estate tax exemption was $5,000,000. In 2012, the exemption was indexed for inflation, resulting in a $5,120,000 exemption.
As 2013 began, Democrats sought a return to the 2009 version of the federal estate and gift taxes, with a $3,500,000 estate tax exemption, a $1,000,000 gift tax exemption, and a 45 percent rate for both taxes. Republicans, on the other hand, wanted to retain the $5,000,000 federal estate tax exemption (indexed annually for inflation), as well as the 35 percent tax rate. In addition, Republicans wanted the estate and gift taxes to remain unified, so that the federal gift tax would have the same exemption amount and rate as the estate tax. Republicans also wanted to maintain the concept of ”portability” of the estate tax exemption, which allows the unused portion of a decedent’s federal estate tax exemption to pass to a surviving spouse, for use by the surviving spouse for gift and estate tax purposes.
The tax law enacted at the beginning of 2013 included almost the entire Republican wish list. The only item on which Republicans did not get their way is the tax rate. Republicans wanted the rate to remain at 35 percent, and Democrats preferred 45 percent. Congress split the difference and enacted a 40 percent tax rate.
So the current federal estate and gift taxes have a 40 percent rate and a $5,000,000 exemption, indexed for inflation. As a result of the inflation adjustment, the exemption increased from $5,120,000 in 2012 to $5,250,000 in 2013. In 2014 and beyond, the exemption will increase each year based on the rate of inflation. Ironically, the inflation adjustment means that the “permanent” estate tax will change every year.
Edwin G. Fee, Jr. is a partner with Whiteford, Taylor & Preston L.L.P., a Fellow of the American College of Trust and Estate Counsel, and a past Chair of the MSBA Estate & Trust Law Section.