Category Archives: estate tax

New Tax Act passed

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I’ve been waiting on Congress to do its job and finally some legislation has come through. There is something in the new Tax Act for everyone.
First, the highlights:
The tax benefits of the 2001, 2003 Tax Acts were extended for two years. This means that the tax rates for 2010 will hold for two more years including on capital gains. With regard to Alternative Minimum Taxes, the relief is in the Act. So, there will not be a jump in people affected by AMT next year.

With regard to Estate and Gift Taxes two huge changes.
(1) Reunification of Gift and Estate tax exemptions. Since 2001, gift tax exemption was capped at $1 Million. Now it will be the same as the estate tax exemption of $5 Million.
(2) Estate tax unified credit increased to $5 Million for years beginning in 2011. There is also a retroactive election for 2010 relating to step-up in basis. If the estate is under $5 Million, it would appear that the one can elect to step-up the basis of the assets. If its above $5 Million we’ll need to assess your personal situation to decide whether you want to pay estate tax to get a step-up in basis. The rate will stay at the current 35% rate for estates over $5 Million. There is also portability for married couples. This means that if one spouse dies after December 31, 2010 and the other dies later and the first spouse used up $3 Million of his or her credit amount, the second spouse can take up to $7 Million of the first spouse’s unused credit. Given the limited period of this law, it might be wise to look at gifts, although there is a basis trade-off if that occurs. Either way, its a huge change in the law.
These changes are only for two years. So, after December 31, 2012, the exemption amount falls back to $1 Million and estate tax rate to 55%.

With regard to the 2% payroll tax holiday for 2011, it also applies to self-employed individuals.

Energy Efficient Home Credit is extended to through 2011. Energy efficient appliances credit is extended through 2011 as well. Credits for windows, wood stoves, water heaters will continue.

Deductions for school teachers shall be continued through 2011. Sales tax deduction continued through 2012. Tax free distributions to charities from retirement plans extended through 2011.
Lots of continuation of popular business credits, research credit, and other industry specific credits.

WHAT THE FAMILY COULD HAVE PLANNED

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First, when the father started the business or at least when the boys started working there, he should have considered giving them portions of the business over the years. This would have created minority discounts in the business upon the deaths of the parents. As to the IRA, when Dad got sick, pop the IRA’s right away and don’t withhold any taxes. That way, you get an income tax deduction on the estate tax return. In essence trading a 39% tax for a 50% tax. Make sure Mom has assets in her name alone in case she were to die first. The family should have utilized revocable trusts and perhaps buy some life insurance owned by a Life Insurance Trust or an LLC owned by the sons. These are minimal steps which might have averted this confiscatory scenario. As you can see, for 2011, things can get real ugly and planning should be done.

What should the boys do?

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A little post-mortem estate planning. First the wife’s executor should disclaim $1.0 Million of assets preferably in the stock of the company (we’ll explain later). That way, his estate gets to use its $1.0 Million exemption and her estate gets to use her $1.0 Exemption. This reduces the tax by $500,000. Not there yet. However, since she disclaimed her interest in the business, it is still worth $2.5 Million, but her interest may be subject to some discounts as high as 25%. This means that her interest may only be $1.0 Million. That leaves the IRA and the houses and the condo to be taxed at $700,000. Sell the houses, since there is no capital gains there and pay the taxes with the proceeds. That leaves the $800,000 IRA which can be drawn down over time.

What the kids are looking at?

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First, the lawyer says to the kids, “we need to determine the value of your father’s business. It throws out an income stream of $300,000 per year. Assuming that you had to hire a manager for $200,000, that’s a $100,000 a year income stream. Given current income rates the amount of principal needed to generate a dividend of $100,000 would be $2.5 Million. So, the store could be worth as much as $2.5 Million, we’ll need to get an appraisal. The rest of the property is pretty easy to determine, its worth about $1.4 Million. So, your dad’s estate is worth $4.9 Million. There is an exemption of $1.0 Million and that’s it. So there will be an estate tax of approximately $2.0 Million on this estate.” The boys were crestfallen. “$2.0 Million? We can’t come up with that kind of money right away.” “It gets worse”, said the lawyer. “Worse, how can it get any worse?” “Well, on the $800,000 retirement account, you have to pay income taxes to liquidate that account. So, you’re looking at income taxes of about $320,000 to take money out of that account in order to pay the estate taxes.” Bruno, Jr. was heart-broken and a bit angry, “you mean that we’ve worked in that store for 20 years smelling feet and in order to continue to own the store we might have to pay the Government $2.32 Million?” “That’s about the size of it”, said the lawyer. “But there is one piece of good news” said the lawyer. “What’s that”? asked Viggo. “The Government might allow you ten years to pay off the tax”.

Update on Section 1022

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At this point the IRS has not issued any guidance that we’ve seen concerning Section 1022 of the Code for allocating basis for decedent’s dying in calender year 2010, as we discussed in February. As you recall, survivors other than a spouse can elect to step-up basis on $1.3 Million of assets and a surviving spouse can elect to step-up basis on up to $3 Million of assets. So at this point, since it appears that Congress is not going to make any changes to the Estate Tax in 2010 or Section 1022. Thus, for families of persons dying in 2010, it would be advisable to talk to your attorney about filing a protective form 706 to elect the basis allocation.