As much as it pains me to say, there may be only a $1 Million exemption in 2011 for estates. So, let’s look at Bruno who owns Bruno’s Shoe Store located in a condo retail park in Fredericksburg, VA. He also made the smart move in 2005 to add a web-site to sell shoes on-line. This has increased his sales greatly. At the end of 2010 his annual sales are $1 Million. He takes out of the store after paying salaries, inventory and usual operating expenses about $300,000 a year. He owns the business as a Sub-chapter S corporation per the recommendation of his accountant. The Condo is owned by an LLC which he and his wife own together. The condo is worth $125,000 and there is no debt. He and his wife own a home in Chancellorsville worth $300,000 and a cabin at Lake Louisa worth $200,000. His retirement account has $800,000 in it and it leaves everything to his spouse. On January 1, 2011, while he is doing inventory a shelf full of shoes falls on top of him, killing him instantly. When he doesn’t come home for dinner his wife calls the store, no answer and then calls the police who discover his body that evening at the store. They inform his wife who is so grief stricken that she has a heart attack and dies two hours later, leaving two adult children, Bruno, Jr. and Viggo. They both worked in the store th elast two years and want to continue the business. They appear at the offices of Slim Shades the noted estate tax attorney, to get advice about the tax effects of all of this.
The verdict
“It means that on the $50 Million of negative capital account you owe ordinary income taxes at your rate. Since this is 2011, you owe them at 39.5%. That translated into $19.75 Million. You also owe capital gains taxes, that translates into $20 Million dollars. You also owe state taxes that translates into $8 Million. So that’s $48 Million dollars. Subtract out the debt of $50 Million. That leaves untaxed $52 Million to be divided among your family members. The family trust gets the entire $52 Million. That means that you won’t see the money until your momma dies. And then you have to divide what’s left among your siblings.” “Oh, that’s pretty bleak” said Delicious.
The story
“Well”, said Snotnose, “you see, your father had a negative capital account in those real estate partnerships. That means that he took losses greater than what he contributed into the partnership. Further his carry-over losses were lost when he died. Because you did not receive a basis increase at his death due to Section 1022, you recognize ordinary income to the extent of his negative capital account.” “How much is that? asked Delicious. “About $50 Million. The rest is capital gain. But of course there is debt on the property of $50 Million” said the lawyer. “So what does all that mean?” asked Delicious
The Negative Capital Account
Meratroid Asteroid dies in 2010. His family is understandably relieved that he owes no estate taxes. He owns a bunch of real estate partnerships totalling $150 Million in value. They have been licking their chops for years to sell the real estate and retire to beaches and fruity rum drinks. So, after his death, they go into their attorney Mark Snotnose. Mr. Snotnose after looking over his half glasses at them with a sneer says, “don’t think you better sell those real estate partnership interest any time soon.” “What do you mean?”, asks daughter Delicious LaTour.
Insights from the Virginia Tax Conference
I attended the Virginia Tax Conference and it was loaded with items of interest and concern in the years to come.
For example the HIRE Act gives some very nice refundable tax credits to employers who hire the unemployed. The Employer has a new form for employees to fill out a W-11 form.
The House of Representatives passed an extenders bill but there are some extenders which were left out. For example Alternative Minimum Tax relief. This means that in 2011, more taxpayers will be subject to AMT. 5 year NOL on carry-backs is going away. Waiver of the minimum distribution rules for 2010. Homebuyer’s credit will not be renewed. Also the capital gain and dividend rates will increase in 2011 if nothing is done. Therefore, expect dividend rates to go up to ordinary income rates and capital gain rates to go up to 20%. If you are a corporation sitting on earnings a profits, it might be a good time to declare a dividend. Tax rates will rise in the top brackets from 35% to 39.5%. So again, for high income taxpayers this is a real problem. Also, your price for indoor tanning just went up. There is a 10% surtax on indoor tanning services. There are 2010 benefits for health insurance for employees that meet certain criteria under the statute. In 2012, new 1099 requirements have been added. In 2013 some whopper tax increases. .9% Medicare surtax on “earned income”. I point this out because there will also be a 3.8% surtax on unearned income. So, there will be a choice for upper income folks as to whether they should shut down those S Corps and convert them to LLC’s since the dividends will have this new 3.8% surtax, but then again, if you have a long way to go to get to the limit on Social Security, it might not be worth it. 2010 might also be the year to convert a traditional IRA to a Roth IRA since (1) rates will increase in 2011, and (2) further increase in 2013.
So, lots of things coming down the pike in the income tax area. But the 2000 pound gorilla in the room is the Estate Tax and capital gains step up in basis for 2010 and years going forward. In 2010, as anyone who has read this blog knows, there is no estate tax this year. What some are now whispering is that Congress may take no action in 2010 on the Estate Tax. That means two things: (1) The exemption in 2011 will be $1 Million. (2) No basis step-up except for the $1.3 Million in 2010. That means for people dying in 2010, they will pay no estate taxes, but their families will for the most part be stuck with their basis. We’ll have some tales about this scenario in days to come. This means in essence that the families will be paying the capital gains on the property even if the person was of modest means. This is a horrible result. As for the 2011 Exemption of $1 Million, this is clearly something that could impact almost anyone who owns a business, or real estate of substantial value. We’ll have some tales about that in the future as well. Clearly, this means that it may be a good year to make taxable gifts late in the year (if Mom or Dad is expected to live past 2010). That would generate a gift tax in 2011 (which could be a deduction for deaths in 2011). This when coupled with low real estate values and stock values comparatively right now, may signal a time to make large gifts. And we’ll discuss all the various gifting techniques out there for implement estate freezes and the like. Some of these will likely be legislatively stopped starting in 2011.