As of December 12, 2012 as I write this newsletter, Americans do not know what will happen to the estate tax law on January 1, 2013. Yes, we know that the exemption for gifts during life, or for gifts at death, or any combination of the two is $5,120,000 for 2012. Yes, we know that the exemption is scheduled to go down to $1,000,000 in 2013. Yes, we know that neither the Democrats nor the Republicans want the exemption to go down to $1,000,000.
How did we get here? When the exemption became $1,000,000 in 2001 (not 2011) there was a sunset provision that said that because the budget didn’t balance, the law would expire. It was scheduled to expire January 1, 2011. But on December 17, 2010, President Obama and the Republicans made a deal to increase it to $5,000,000 for 2011($5,120,000 for 2012).
But because the Republicans wished to continue to work to abolish the estate tax, this ‘deal’ was a two year deal, expiring January 1, 2013. Thus the rule that the law would go back to the $1,000,000 exemption of 2001 was extended two more years.
Some people are considering making large gifts before January 1, 2013 in the hope that these gifts will be grandfathered, ie in the hope that if the exemption is less in the year the donor dies, the donor will qualify for the higher exemption because of the large lifetime gift. It is not clear whether or not grandfathering will be allowed because of the possibility of ‘clawback’ meaning that gifts during life will be added back into the estate tax return but the exemption might be restored only up to the date of death exemption amount.
Many commentators believe there will be grandfathering rather than clawback, but even if there is grandfathering, this strategy will only work if the exemption goes down, ie if the exemption stays at $5,120,000, there will be no grandfathering.
Also, if gifts of appreciated assets are made during life, the step-up in basis that occurs (for income tax purposes) when a person owns assets at the time of his or her death will have been lost and this negative result has to be weighed against possible estate tax benefits.
Finally, to have the lifetime gift recognized as a completed gift for estate tax purposes, the donor must be prepared not to get any benefits from the assets given away during life, for example the donor should not try to have his or her children pay his or her expenses from the gifted property.