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Fiscal Cliff “Agreement” Reached: What It Means For Your Estate

As most people already know, Congress and the White House reached a deal this week to halt the implementation of the “fiscal cliff” changes related to tax increases and spending cuts. While the agreement was reached after the start of the new year, this is nothing more than a technicality as the actual facets of the cliff will be avoided.

The political wrangling surrounding the passage of the agreement was a bit of political theater. The Senate passed the bill on December 31st with broad bipartisan support. The details of the agreement were hashed out by Senate Republican leader Mitch McConnell and Vice President Joe Biden, and so with representatives from both parties involved it was easy to get sufficient support to pass the measure out of the Senate. The House of Representatives was a different matter, with the majority Republican caucus is disagreement about whether they would even allow a vote on the Senate bill. In the end, in a maneuver that surprised many, the legislation was called and some Republicans voted for the measure,
along with a majority of Democrats, to pass the bill.

So what does it all mean?

The most obvious estate planning implication is the permanent change in the estate tax. Per the terms of the compromise bill, from now on the top tax rate is 40%–an increase from the previous 35% level.
The exemption level will also remain at $5 million. This is actually a win for those who support a lower estate tax, as the White House was calling for a 45% rate and a $3.5 million exemption level. The higher exemption level means that fewer families will reach the threshold and need to make alternative arrangements to avoid the hefty inheritance tax.

In addition, there were some concerns that an agreement would limit the ability of community members to make deductions for things like charitable contributions. Many residents use donations as part of their long-term estate planning. However, the agreement makes no alteration to the current policy of allowing these payments to be deducted.

Beyond that, there are many other tax and savings issues affected by the agreement. The payroll tax reduction will expire, income tax rates permanently rise on those making over $400,000 ($450,000 for couples), and capital gains tax rate increase for those same high income earners.

Interestingly, retirement account options will also change. Many community members take advantage of specialized 401(k) accounts to save for when they are no longer working. These accounts allow the contributions to be deducted; taxes are then paid upon disbursement. However, according to the fiscal cliff compromise, those accounts will be rolled into Roth IRA plans. The Roth IRA plans are essentially the opposite of the 401(k) in that the contributions to the account cannot be deducted, but there is no tax when withdrawals are made down the road. The basic idea is that this switch will likely provide more federal funding in the short term and less in the future.

As always, it is important to have tailored legal advice whenever you have questions about how legal changes might affect your long-term planning. In the San Diego area, the estate planning attorney at our office is available to provide the guidance you need.

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