Federal Gift and Estate Law in 2013 and Beyond

The federal estate tax will continue to affect only the richest families in America, under legislation passed by Congress on New Year's Day 2013. This last-minute lawmaking allowed the government to avoid the "fiscal cliff" of tax increases and big spending cuts, which many economists predicted would tilt the country back into recession.

Had Congress not addressed the estate tax, it would have reverted to an exemption of $1 million, with a 55% top rate, on January 1.  The tax changes will cost the government $396.068 billion over ten years, according to an estimate in the Senate Finance Committee’s summary of the legislation, which is called the American Taxpayer Relief Act of 2013.

Exemption Amounts

Effective immediately, every person may leave or give away up to $5.25 million without owing any estate tax. As a practical matter, that means that under the new rules about 99.5% of all estates will NOT owe any federal gift/estate tax.

The exemption amount was $5.12 million in 2012; it's based on the $5 million 2011 amount, adjusted for inflation. The exemption amount will continue to be indexed for inflation each year. Unlike legislation enacted in the last several years, there is no sunset provision for these amounts; indexed for inflation, they will stay in force until Congress changes them again.

‘Portability’ for Spouses

One popular feature of the current estate tax law is that spouses can combine their estate tax exemptions, effectively letting married couples give away or leave more than $10 million without owing tax. The new law makes this feature, called “portability” by tax experts, permanent.

Here’s how it works: If the first spouse to die doesn’t use up his or her individual gift/estate tax exemption, the surviving spouse can use what’s left. That gives the couple a total $10.5 million exemption, which they can share in the way that provides the greatest tax benefit. For example, if each member of a couple has $3 million in assets, and the first one to die leaves everything to the other, no estate tax is owed because property left to a spouse is tax-free. When the survivor dies and leaves $6 million ($3 million plus the $3 million inherited from the other spouse) to their children, no estate tax will be due, even though the estate is over the exemption amount, because the estate can use $500,000 of the first spouse’s unused exemption.

To take advantage of the portability rule, an estate tax return must be filed when the first spouse dies--even if no tax will be due. As commentators have pointed out, this means the IRS must process returns that don't provide any tax revenue, and taxpayers must pay experts to prepare these very complicated tax returns.

Gift and Estate Tax Rates

On very large estates subject to the tax, the gift/estate rate is now 40%. This is an increase over the 2012 rate of 35%, but the rate remains lower than those that have been in effect since the 1930s.

This rate also applies to the generation-skipping transfer tax. That is a federal tax that is imposed on large transfers that skip a generation (for example, a gift from a grandparent to a grandchild) in an attempt to avoid estate tax.