The American Tax Relief Act of 2012 – Guidance on Estate Planning

Julie M. Karavas


The American Tax Relief Act of 2012 was signed into law December 31, 2012, to avert falling off of the “fiscal cliff”.  The Act provides us with guidance on estate planning with the following provisions.


Federal Estate Tax

 The compromise kept the federal estate exemption at $5.25 million for individuals ($10.5 million for married couples) and a tax rate is 40% for amounts over the exemption, meaning the exemption amount did not drop to $1 million per individual as it was scheduled to do.  The exemption amount is indexed for inflation.  We also learned that the estate tax exemption will continue to be portable between spouses. This means that the value of a married couple’s estate is not valued for estate tax purposes until the death of the second spouse since a surviving spouse can use the decedent spouse’s unused federal estate tax exemption without having to rely on trusts.  However, there are non-tax reasons a bypass trust will continue to be useful, including situations in which the surviving spouse might remarry, or in which the assets might appreciate in value.  In addition, if your plan already includes a bypass trust (also referred to as an “A-B trust”) for federal estate tax planning, it is not necessary to immediately change your plan and get rid of the bypass trust especially if you have funded that trust, meaning assets are titled in the name of the trust.

Federal Gift Tax

The gift tax remains unified with the estate tax.  A unified estate and gift tax exemption means that the $5.25 million threshold is applied to total transfers, whether by gift during lifetime or inheritance on death.  And, similar to the estate tax exemption rate, the gift tax rate is 40% for amounts over the exemption.

Charitable IRA Rollover

The extension of the Charitable IRA Rollover provided by the law is significant. This provision permits tax-free distributions to an eligible charity from an IRA held by someone age 70½ or older of up to $100,000 per taxpayer, per taxable year. For married couples, each spouse can transfer up to $100,000 per year from his or her IRA. The provision includes two transition rules which allowed donors to make contributions for 2012.  First, individuals who received an IRA distribution in December 2012 were able to elect to count that distribution (or a portion thereof) as a 2012 Charitable IRA Rollover provided the individual transferred the amount in cash before February 1, 2013, to an eligible charity. Second, donors were able to have IRA distributions made directly to eligible charities before February 1, 2013, and elect to have such distributions treated as qualified charitable distributions for 2012. This change was of interest to donors who wished to take advantage of the rollover in both years. 

 Capital Gains Tax 

Capital gains tax, while an income tax and not an estate tax, does relate to estate planning.  The tax rates on long-term capital gains and dividends will remain at 15% for most individuals. However, the maximum rate for higher-income individuals increases to 20 percent (up from 15 percent). This change affects singles with taxable income above $400,000, and married joint-filing couples with income above $450,000.

Investment Income Tax (Medicare surtax)

In addition individuals with adjusted gross income in excess of $200,000 and married couples with adjusted gross income in excess of $250,000 will also get hit with the new 3.8 percent Medicare surtax on investment income effective January 1, 2013, which can result in a maximum 23.8 percent federal tax rate on 2013 long-term gains and dividends.  This surtax is not part of the Act as it is a component of the Health Care Act, but is related to other estate-related tax issues.  This new tax is complex, but in effect it is a flat tax on investment income above the $200,000/$250,000 threshold. Note that while the tax applies only to investment income above the threshold, other income—such as wages or Social Security—can raise adjusted gross income, making investment income more vulnerable to the tax.

Absent guidance from the IRS, it is suggested that the 3.8% tax applies to dividends; rents; royalties; interest, except municipal-bond interest; short- and long-term capital gains; the taxable portion of annuity payments; income from the sale of a principal home above the $250,000/$500,000 exclusion; a net gain from the sale of a second home; and passive income from real estate and investments in which a taxpayer doesn't materially participate, such as a partnership.

In contrast, it is believed the tax doesn't include payouts from a regular or Roth IRA, 401(k) plan or pension; Social Security income; or annuities that are part of a retirement plan. Also not included are life-insurance proceeds; municipal-bond interest; veterans' benefits; Schedule C income from businesses; or income from a business on which you are paying self-employment tax, such as a Subchapter S firm or a partnership.

For example, a married couple filing jointly has $400,000 of adjusted gross income—$240,000 of wages plus $160,000 of investment income composed of interest, dividends and net gains from the sale of raw land. This results in $150,000 of investment income above the $250,000 threshold, and accordingly they would owe an extra 3.8% of that amount, or $5,700, in tax.


These listed tax changes are permanent (until further notice).  This is a confusing statement.  The reason the law is said to be permanent, is that it does not contain a “sunset” provision as did the estate tax law in place for 2011 and 2012, which provided the $5 million exclusion amount would sunset at the end of 2012, and the exclusion amount would be $1 million if there was no compromise.

What does this mean to you?  From a federal estate tax perspective married couples with combined estates valued at less than $10 million do not need to prepare estate plans with bypass trust provisions.  However, such a statement is only correct with the current law – and there is no indication how long it will be “permanent.”  And, as stated above, there are a number of non-estate tax reasons to include a trust in an estate plan.  Many of the non-tax issues have not been affected by the tax law changes and remain important issues to be considered as you plan for the management of your estate during your life, and after your passing.