Congress provides business owners a grappling hook

Yes Virginia, there is a Santa Claus, and yes Virginia business owners, Congress did provide estate tax relief by enacting the American Taxpayer Relief Act of 2012.  The relief is not a first class ticket off the cliff, as that would have been estate tax elimination, but considering the alternatives, it is a soft descent down the cliff.

Many business owners will be protected from estate tax because the exemption amount will remain at the $5 million amount, indexed for inflation.  Also, just as important, the new law is “permanent,” to the extent any federal tax law subject to politics is permanent.

Among the estate tax alternatives considered prior to the new law were a roll back to pre-Bush tax cuts, which would have meant a $1 million exemption amount and, just as bad, a short-term fix that provided instability and inability to plan for wealth preservation.  Further, the new law eliminated a tax “clawback,” i.e., the possibility that taxpayers who made gifts in 2011 or 2012 would pay tax if the exemption amount fell to $1 million.

Here are some observations regarding the 2013 law, and the gifts that occurred in 2012:

1) Congress did not eliminate the estate tax, but that was not expected. Congress did maintain the estate exemption amount, and significantly the gift amount, at $5.12 million with continued inflation adjustments.  Thus, a married couple can shelter more than $10 million from estate tax. Because President Obama wanted a $3.5 million exemption, and only a $1 million exemption for gifts, this provision is as beneficial as could be expected.  The maximum estate tax rate for estates exceeding the exemption amount does increase from 35 percent to 40 percent.

2) A significant advantage is retaining the same $5 million amount for gift purposes.  Thus, business owners can make lifetime gifts, rather than wait until death, to remove assets from their estates. Current gifts allow a business owner to remove asset appreciation from his estate. It also allows the business owner to position the assets to take advantage of discounted asset values for gift tax purposes.

3) Also significant are the changes that Congress did not enact — or at least not yet.  Treasury has considered curtailing or eliminating transfer techniques utilized by business owners in 2012, such as dynasty trusts, two-year GRATS (Grantor Retained Annuity Trusts), intra-family discounting, and sales to intentionally defective trusts.  So far, all of these techniques remain viable. This leads us to a fourth observation.

4) Many of those who acted in 2011 and 2012 benefitted from the techniques noted in Observation 3 and from low asset values. There will likely be some transferors who, in retrospect, question why they acted now that the $5 million exemption remains.  For example, the family of a business owner, who transferred assets at a carryover basis and then dies a premature death, may have been better off if the business owner had retained the assets at his death and received a stepped up basis.  However, the majority of business owners who gifted closely held business interests or real estate in 2012 benefited from not only a $5 million exemption amount, but also from the transfer techniques noted above that may not be available in 2013 and beyond.  Those business owners with significant assets who did not act before 2013 may still want to do so to take advantage of the transfer strategies.

5) Another advantage of 2012 transfers:  there will be a flood of gift tax returns filed in 2013. Provided the taxpayer “adequately discloses” the gift on his 2012 Form 709 gift tax return, the IRS will have three years to audit the return, similar to an income tax return. After three years, the gifts and their values are locked in for gift tax purposes.  Thus, although no sound planning is ever based on “playing the audit lottery,” all of us would prefer to avoid an IRS audit.

6) Virginia does not have a state estate tax.  Thus, married Virginia business owners do not have to worry about federal or state estate taxes for assets under $10.24 million.  In other states, such as Maryland or in Washington, D.C., the state exemption amount is only $1 million upon death, but there is no gift tax.  Thus, Maryland and D.C. residents should consider lifetime gifts to remove assets from their estates — a savings of 16 percent over $1 million.

7) Another advantage of the new law is the preservation of “portability.”  Portability allows a married couple to utilize both of their exemption amounts, without splitting assets and creating trusts for each other.  A discussion of portability is beyond this article, but suffice to say the concept serves a useful purpose, even if only as a fall back for taxpayers who have failed to do lifetime planning.

Nothing is certain but death and taxes, but finally, Congress provided some certainty and relief for taxpayers doing estate tax planning.  Under the American Taxpayer Relief Act of 2012, many well off business owners can now utilize basic estate planning to transfer their business free of these taxes.  However, for business owners with $10 million or more of assets, lifetime transfers and advanced planning will continue to play a prominent role.

John P. Dedon is a principal in the firm with the Trust, Estate & Tax Planning practice group of Odin, Feldman & Pittleman. Dedon blogs about estate planning issues for Virginians and U.S. citizens at http://www.dedononestateplanning.typepad.com.