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Maximize Wealth Retention Under Temporary Tax Laws in Effect for 2012

As the old adage goes, nothing in this world is certain but death and taxes. Unfortunately, in recent times this saying is more pertinent than ever, as there is now a direct and immediate link between taxes and the end of life.

Known derisively by some as the death tax, the federal estate tax (along with its cousins, the generation-skipping tax and the gift tax) can take a substantial bite out of intergenerational wealth. However, a tax relief package in effect until the end of 2012 can help you and your estate planning attorney develop an effective strategy to limit your potential tax liability.

What Are the Estate, Generation-Skipping and Gift Taxes?

For the uninitiated, the various taxes surrounding the transfer of assets to heirs can be a significant source of confusion. The first step in crafting a beneficial estate plan is gaining a basic understanding of the federal estate, gift and generation-skipping taxes.

The estate tax is fairly straightforward: when an individual passes away, the value of any assets passed on to his or her heirs is taxed at a certain percentage. First enacted in the United States in 1916, the estate tax rate and exemption level (the amount that may be passed on free of tax) change with the ebb and flow of new legislation.

The gift tax is imposed on gratuitous transfers of property made during the life of an individual – it prevents people from escaping estate tax liability by gifting away all their property while alive.

The generation-skipping tax is a tax on assets transferred to relatives more than one generation younger than the donor (like grandchildren or great-grandchildren) or to unrelated persons more than 37.5 years younger than the donor. The generation-skipping tax will only be imposed if the transfer avoids liability for gift or estate taxes at each generational level. Like the estate tax, the gift tax and the generation-skipping tax have had variable rates and exemptions over time.

TRA 2010 and the Favorable Tax Policies It Extends To the End Of 2012

On Dec. 10, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act – known as TRA 2010. TRA 2010 had broad implications for a variety of taxes; in the estate planning realm, it established more taxpayer-friendly rules and exemptions until 2013.

Under the TRA’s predecessor legislation that expired in 2010, the estate tax and generation-skipping tax were discounted from 2001 on and eliminated completely in 2010 (the gift tax remained in effect at a reduced rate of 35 percent). While this legislation already meant significant tax savings over pre-2001 levels, TRA 2010 contains more good terms for taxpayers in 2011 and 2012.

Under TRA 2010, the effective tax rate in 2011 and 2012 for estates, generation-skipping transfers and gifts is 35 percent. For a frame of reference, in 2009 estates and generation-skipping transfers were taxed at 45 percent and 41 to 45 percent, respectively; the pre-2001 estate tax rate was 55 percent.

In addition, TRA 2010 establishes the most generous estate tax exemptions in history: an exemption of $5 million for the estate and generation-skipping taxes in 2011 – $5.12 million in 2012 – and a $5 million lifetime gift tax exemption for 2011 and 2012. Among other things, this means that any estate valued at $5 million or less is subject to zero tax liability in 2011 or 2012. Prior to TRA 2010, the largest exemptions for estate, generation-skipping or gift taxes was $1 million.

One other important provision of TRA 2010 is the allowance it makes for estate tax portability between spouses. If an individual passes away in 2011 or 2012, the unused portion of his or her estate tax exemptions may be used by a surviving spouse.

For example, imagine a husband dies in 2012, leaving a $3 million estate that passes to his heirs. None of this estate is taxed, as it is well below the $5 million exemption for 2012. However, the unused $2 million of the husband’s exemption total does not have to go to waste: if he is survived by his wife, she may roll the unused amount of his estate tax exemption into her own. Thus, in this scenario, under current tax laws, up to $7 million of the wife’s estate would be except from the estate tax.

One caveat: even if no tax is owed on an estate, in order to preserve the unused portion of a spouse’s exemption, the surviving spouse must file a timely estate tax return.

What Happens in 2013 and What You Should Do To Prepare

If Congress takes no action, the estate, generation-skipping and gift taxes will revert in 2013 to their pre-2001 levels. This would mean rates of between 41 and 55 percent, and exemptions of about $1 million.

This outcome is unlikely. Congress is expected to enact new rules governing estate, generation-skipping and gift taxes by 2013. Still, there is no way to know whether the new laws will be more favorable than the current rules – and, given the extremely generous nature of current estate tax provisions, it is unlikely that the new rules will be quite so taxpayer friendly.

So what are thrifty taxpayers to do? Thorough estate planning completed before the end of 2012 can mean thousands – even millions – in savings. Preserving the unused exemptions of a deceased spouse, taking advantage of the currently large exemptions for gift and generation-skipping taxes and a number of other strategies under the guiding provisions of TRA 2010 make this year a good one to contact an estate planning attorney.

You have worked hard your whole life to gather and hold on to your wealth – you should not let the government take more than its fair share when it comes time to pass on your hard-earned assets to your heirs. Get in touch with a lawyer today to learn more about how the favorable tax rules of 2012 could pay off handsomely in terms of your long-term estate plan.