Estate Tax

The U.S. Supreme Court’s Decision in U.S. v. Windsor and Its Effect on Estate Planning

On June 26, 2013, the United States Supreme Court issued an opinion, U.S. v. Windsor, in which it struck down a major part of the Defense of Marriage Act (DOMA) as unconstitutional because it denies same sex couples equal protection under the law in violation of the Fifth Amendment.  In that case, Edith Windsor, who was married to her same sex partner in New York, where the couple also resided, and which recognizes full marriage rights for same sex couples, was denied the opportunity to claim the marital exemption from federal estate taxes upon her partner’s death based on the definition of marriage under Section 3 of DOMA.  This Section defines marriage for federal purposes as “only a legal union between one man and one woman.” 1 U.S.C. § 7.  The U.S. Supreme Court, however, in a 5-4 decision determined that Section 3 of DOMA unconstitutionally denied Edith Windsor from taking advantage of the estate tax marital exemption, which would have been available to opposite sex married couples.  This thus violated the Fifth Amendment’s directive for equal protection under the laws by singling out and demeaning a certain class of people – same sex couples.  The Court also indicated that this provision interferes with the states’ power to regulate marriage.  Therefore, the Court struck down this section of DOMA.  Windsor, No. 12-307 (U.S. 2013).  For further information on the Windsor decision, see the article, “Supreme Court strikes down Defense of Marriage Act in estate tax case” at http://www.journalofaccountancy.com/news/20138222.htm.  See also the article, “The Same Sex State Death Tax Trap Post DOMA” at  http://www.forbes.com/sites/ashleaebeling/2013/07/01/the-same-sex-state-death-tax-trap-post-doma/.

The effect of this ruling is that legally married same sex couples can now claim the same federal benefits and marital tax exemptions as opposite sex married couples can.  It remains unclear, however, whether federal benefits will be available to same sex couples who do not live in a state that recognizes same sex marriage.

What this means for estate planning is that the same estate planning tools and techniques utilized in opposite sex couples’ estate plans to minimize the federal estate tax owed may be used in same sex couples’ estate plans in states that allow same sex marriage.  In states that do not recognize same sex marriage, however, these estate planning techniques would not be effective and same sex couples in those states would not be able to avoid estate taxes in that way.

In Wisconsin, though domestic partnerships are recognized between same sex couples, same sex marriage is not.  It is therefore uncertain whether same sex couples would be able to take advantage of the federal estate tax marital exemption, since these couples cannot be legally “married” in Wisconsin.  We are hoping, however, that both the federal and state governments will provide guidance as to these issues and questions in the near future and will establish processes and procedures that will facilitate the implementation of these new policies.

What to Expect From the New Tax Bill

On January 1, 2013, Congress finally passed a tax bill that avoided the so-called “fiscal cliff” and included significant changes to the tax laws.  Some of the key provisions are summarized here.

The change that will probably have the greatest impact on most taxpayers is the expiration of the payroll tax reduction.  Congress did not renew the 2% payroll tax holiday, so the employee portion of the Social Security tax will return to 6.2%, thus decreasing slightly most employees’ paychecks.

Also of significant impact: the Bush income tax cuts were made permanent for all but the highest-income-earners.  For this purpose, the highest-income-earners are those who have taxable income over $400,000 for singles and $450,000 for married couples.  The income tax rate for them was raised from 35% to 39.6%.  The capital gains tax rate on these highest-income-earners was also increased to 20%.

This chart, from the Kiplinger Tax Letter, summarizes the income tax rates for 2013:

Marrieds: If taxable income is The tax is
Not more than $17,850 10% of taxable income
Over $17,850 but not more than $72,500 $1,785.00 + 15% of excess over $17,850
Over $72,500 but not more than $146,400 $9,982.50 + 25% of excess over $72,500
Over $146,400 but not more than $223,050 $28,457.50 + 28% of excess over $146,400
Over $223,050 but not more than $398,350 $49,919.50 + 33% of excess over $223,050
Over $398,350 but not more than $450,000 $107,768.50 + 35% of excess over $398,350
Over $450,000 $125,846.00 + 39.6% of excess over $450,000
Singles: If taxable income is The tax is
Not more than $8,925 10% of taxable income
Over $8,925 but not more than $36,250 $892.50 + 15% of excess over $8,925
Over $36,250 but not more than $87,850 $4,991.25 + 25% of excess over $36,250
Over $87,850 but not more than $183,250 $17,891.25 + 28% of excess over $87,850
Over $183,250 but not more than $398,350 $44,603.25 + 33% of excess over $183,250
Over $398,350 but not more than $400,000 $115,586.25 + 35% of excess over $398,350
Over $400,000 $116,163.75 + 39.6% of excess over $400,000
Household heads: If taxable income is The tax is
Not more than $12,750 10% of taxable income
Over $12,750 but not more than $48,600 $1,275.00 +15% of excess over $12,750
Over $48,600 but not more than $125,450 $6,652.50 + 25% of excess over $48,600
Over $125,450 but not more than $203,150 $25,865.00 + 28% of excess over $125,450
Over $203,150 but not more than $398,350 $47,621.00 + 33% of excess over $203,150
Over $398,350 but not more than $425,000 $112,037.00 + 35% of excess over $398,350
Over $425,000 $121,364.50 + 39.6% of excess over $425,000

The standard deduction and personal exemptions were raised slightly, but these, along with itemized deductions, are being phased out for high-income-earners.  For these purposes, high-income-earners are those whose Adjusted Gross Income (AGI) is over $250,000 for singles and $300,000 for married couples.

The alternative minimum tax (AMT) exemptions were also increased and will be permanently adjusted for inflation.

The Medicare surtax for high-income-earners (total earnings of over $200,000 for singles and $250,000 for married couples), which was included in the health care reform bill, will take effect in 2013, as will the Medicare surtax on net investment income for high-income-earners (modified AGI of over $200,000 for singles and $250,000 for marred couples), both at the rate of 3.8%.

The tax rates for Social Security will also be higher, due to the expiration of the 2% tax holiday and the 0.9% increase for high-income-earners, mentioned above.  The Social Security wage base, however, was raised to $113,700, and Social Security benefits go up by 1.7%.

With regard to the federal estate and gift tax, the $5 million exemption was made permanent and was increased for inflation to $5.25 million in 2013 and will continue to be indexed for inflation.  This continues to be the unified exemption amount for the estate and gift tax, and it continues to be portable between spouses.  Portability means that a married couple has $10.5 million in exemption between the two of them with the first spouse to die passing his or her unused share to the surviving spouse.  In order to use this portability, however, the surviving spouse must file an estate tax return indicating that election.  The tax rate on estates beyond the exemption amount was increased from 35% to 40%.

The annual gift tax exclusion was also increased to $14,000 per donee.  This means that in 2013 a person may gift $14,000 per donee without being required to report it or count it towards the $5.25 million lifetime exemption amount.

If you have questions regarding the new tax laws or about how these changes will affect your estate plan, please contact us, and we will be pleased to assist you..

Estate Taxes: The Lifetime Exemption

Over the past 18 months, the estate tax has been a hot topic in the news and on the floor of Congress.  Sometimes referred to as the “death tax”, the estate tax is a tax levied on “the transfer of the taxable estate of every decedent who is a citizen or a resident of the United States.”  26 U.S.C. § 2001(a).  A “decedent” is a deceased individual.  The decedent’s “taxable estate” includes the assets in a decedent’s estate after applying deductions.  Several of the available deductions and exemptions will be discussed in future posts.  For now we will just discuss the biggest of them all, the “lifetime exemption.”

The lifetime exemption gets all of the press when the media is discussing the estate tax.  When you someone in Congress or on cable TV ranting about the “estate tax” or “death tax”, this is what they are talking about.  Essentially, the lifetime exemption provides an individual the right to pass a specific dollar amount’s worth of assets to whomever they desire without incurring tax on those transfers.  Below is a chart of the federal lifetime estate tax exemptions for the past ten years and for next year:

Year Exclusion Amount Top Tax Rate
2001 $675,000 55%
2002 $1 million 50%
2003 $1 million 49%
2004 $1.5 million 48%
2005 $1.5 million 47%
2006 $2 million 46%
2007 $2 million 45%
2008 $2 million 45%
2009 $3.5 million 45%
2010 Repealed [1] 35%
2011 $5 million 35%
2012 $5 million 35%

To illustrate the lifetime exemption, assume that a single individual died in 2011 and has $6 million in assets.  Let’s also assume that the decedent does not read this blog, has not come in to meet with one of our estate planning attorneys and thus has not taken advantage of any other estate tax minimizing strategies (which will be discussed in future posts).  Given the $5 million lifetime exemption in 2011, the first $5 million of the decedent’s assets may be passed to his or her heirs tax free.  The remaining $1 million, however, will be subject to the estate tax ($1 million x 35% = $350,000.00 in taxes to be paid).

The estate tax is owed by the estate, not the recipients of the decedent’s assets.  Thus, the estate will have to withhold sufficient assets to make the $350,000 estate tax payment.  This means that $350,000 of assets, at least some of which could have gone to the decedent’s heirs, will have to be sold and paid to the IRS.  Accordingly, the personal representative of the estate should not disburse the estate property until the estate tax is paid (or until he or she knows how the estate tax will be paid from the estate assets).

Over the coming weeks we will discuss strategies by which the decedent could have reduced or potentially eliminated the estate taxes owed.  Stay tuned!



[1] An individual dying in 2010 would not have to pay any estate tax to transfer their assets to heirs, etc.  At the time, some were worried that allowing the estate tax to lapse would result in this.  In actuality, those concerns were largely unfounded, but there were some stories of estates legally transferring immense wealth to their heirs free of taxation. Like this one and this one.

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State of the Estate Tax

Many clients are concerned about the possible taxation of their estate upon death.   Estate planning methods are available to clients seeking to avoid/minimize estate taxes, but the shifting legislative landscape makes planning a challenge.   Let’s review recent developments regarding the federal estate tax, and examine current estate tax law.

In 2001, Congress passed estate tax legislation that resulted in an increasing exemption amount over time.  For example, the exemption increased in increments from $675,000 in 2001 to $3.5 million in 2009.  The exemption (often referred to as the “applicable exclusion amount”) is the amount of wealth (including life insurance proceeds, retirement benefits, etc.) that an individual can pass free of federal estate tax to his/her loved ones.  The 2001 legislation provided that 2010 would be a year without a federal estate tax, absent further Congressional action.

On December 17, 2010, the President signed legislation that set the estate tax exemption at $5 million for 2010 through 2012.  (For 2010, an estate can opt out of the new law, but must then limit its ability to adjust cost basis.)  Moreover, the exemption is now transferable (“portable”) between spouses, effectively providing married couples with $10 million of federal estate tax exemption*.  If Congress fails to revisit this issue prior to the end of 2012, the estate tax exemption will drop to $1 million on January 1, 2013.

Given the volatility of federal estate tax law, you should stay apprised of any changes to the law that might cause you to re-examine your estate plan.

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* For purposes of this summary, it is assumed that the spouses are U.S. citizens..