How the Expiring Bush Tax Cuts Will Affect You

Authored by Wendy Witt, Esq.

If the calendar flips to January 1, 2013 without Congress taking action, you may pay taxes you thought you'd never pay. This article explains sunset provisions as well as several of the main changes that may increase the taxes you pay.

What Does "Current Tax Laws Sunset" Mean?

The term, "sunset", is used to describe laws that end at a certain time if Congress doesn't update the law. While most laws continue until affirmatively changed by the legislature, sunset laws change if the legislature fails to act.

In this article, we're referring to the "The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act" (aka "TRA 2010") that extended the Bush tax cuts.

Under current law, if Congress doesn't vote to continue the Bush tax cuts, tax rates will increase and tax exemptions will decrease, significantly.

Why Will I Pay More Taxes In 2013 Than in 2012?

If the Bush tax cuts do sunset on December 31, 2012, the law will revert back to previous law. There will be a significant increase in capital gains and estate related taxes.

For example:

  • The long term capital gains tax rate will increase from 15% to 20%.
  • Dividends will be taxed as ordinary income. This is a change from 15% to as high as 39%.
  • Gift tax rates increase from 35% to 55%.
  • Federal estate tax rates increase from 35% to 55%.
  • Generation skipping tax rates increase from 35% to 55%.
  • The lifetime gift tax exemption will be reduced from $5.12 million to $1.4 million.
  • The federal estate tax exemption will be reduced from $5.12 million to $1.4 million.
  • The generation skipping tax exemption will be reduced from $5.12 million to $1.4 million.
  • Portability will be eliminated.

How Does the Reduction in an Exemption Mean I'll Pay More?

Good question. If you transfer assets higher than the exemption amount, more than 1/2 of that amount will be paid in federal transfer taxes.

An exemption amount is like a coupon. If the coupon is reduced in value, you'll pay more.

BEFORE the Bush tax cuts expire: Liza dies December 31, 2012. She passes $3 million to her children. There is no federal estate tax because the exemption is $5.14 million and Liza's estate tax is smaller than the exemption.

AFTER the Bush tax cuts expire: Liza dies January 1, 2013. She passes $3 million to her children. There is a federal estate tax of approximately $1 million because the exemption is $1.14 million and Liza's estate tax is larger than the exemption.

That's a $1 million dollar difference between Liza's death on December 31, 2012 and her death on January 1, 2013.

What Does the Federal Estate Tax Tax?

Yes, we really meant to say, "tax tax". The federal estate tax is a transfer tax on everything you own and everything you have a right to at your death.

Many folks think they'll never have enough money to be subject to the tax, but are often surprised when they add everything up. We suggest that you jot down a list of your assets and their approximate values.

Be sure to include real estate, time shares, life insurance, retirement accounts, personal collections, investment accounts, vehicles, bank accounts, monies owed to you, and contracts you have a right to. Estate values add up fast.

What's the Generation Skipping Tax?
The government wants to tax the transfer of wealth at every generation. If you try to skip a generation (e.g. give money to your grandchildren instead of your children), the generation skipping tax kicks in on top of the federal estate tax.

The double taxation is confiscatory taking, in combination, about 90% of the assets transferred. It's shocking and does happen.

What is Portability?

Portability is a law that allows a surviving spouse to use any leftover federal estate tax exemption his or her now deceased spouse didn't use. Portability was Congress's attempt to allow married couples to use both exemptions without proper estate planning.

Perhaps good in theory, however, portability has been riddled with unanswered questions and problems. You likely don't need to be concerned with the pitfalls of portability because it's set to disappear as the law sunsets on December 31, 2012.

However, in the event portability is continued or reestablished at a later date, consult with your estate planning attorney about whether you can depend on portability or not. Many professionals are recommending that married couples use traditional AB trust planning to make the most out of both spouse's exemptions because of portability's unresolved problems.

An Important Warning for Same Sex Married Couples

The federal law does not yet recognize same sex marriage eventhough a growing number of states do. Eventually the Defense of Marriage Act will be overturned, but in the meantime, there is no unlimited marital deduction for at death transfers (or lifetime gifts).

This means same sex couples are more likely to get slammed with federal estate taxes at the death of the first spouse to die instead of the second spouse to die (as is the case with many hetero sex couples).

A qualified estate planning attorney can help you to develop an estate plan that will minimize or eliminate transfer taxes and protect your spouse.

What the Pending Sunset Means for You?

Uncertainty can be quite disconcerting. No experts know whether Congress will act by the end of the year or not.

We think it's essential that you get good advice to know how you can best reduce or eliminate the tax effects of the sunset provisions.

  • Meet with your CPA, financial advisor, or tax attorney to plan ahead for changes in the income tax laws capital gains and qualified dividends.
  • Meet with a qualified estate planning attorney to update your estate plan to deal with the reduction in federal transfer tax exemptions and elimination of portability.

Whether your plan ahead or not may mean the difference in million of dollars for you and your family.

You can find and select both tax attorneys and estate planning attorneys through our website, www.attorneys.org. The site is free and private. In addition, if you contact an attorney through out site, you'll be entitled to a free case evaluation.

In addition, you can ask a friend for a referral to a qualified attorney or ask the bar association for a list of tax lawyers and estate planning lawyers.

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