PLANING IDEAS UNDER THE NEW TAX LAW
RE: PLANING IDEAS UNDER THE NEW TAX LAW
On December 17, 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Tax Act”) was enacted into law. Some planning ideas under this new Tax Act are discussed below:
1. Enactment of Favorable Estate Tax Provisions.
The Tax Act allows parents and grandparents to now transfer substantial wealth tax free to their children and grandchildren — the greatest opportunity since the modern-day estate tax was enacted in 1916. The lower 35% maximum estate and gift tax rates and the higher $5,000,000 gift and estate tax lifetime exemption will remain in effect for only two years — 2011 and 2012. If Congress does not enact a new tax law, then in 2013, the estate tax law reverts to the law in existence in 2001 (which provided for a 55% estate and gift tax rate and a $1,000,000 exemption for both estate and gift taxes).
1.1 New Opportunities for Clients to Make Major Tax-Free Gifts to Children and Grandchildren. For the 2011 and 2012 tax years, the estate and gift tax exemption amount is reunified to $5,000,000 per person , with an estate and gift tax rate of 35% above this exemption amount. Therefore, a husband and wife together could gift $10,000,000 of assets to their children gift tax free, and any amount over such $10,000,000 gift would be taxed at a 35% rate. Additionally, Congress has left in place the ability to use minority and lack of marketability valuation discounts, along with family partnerships and grantor retained annuity trusts (known as “GRATs”).
Planning Idea: Clients should consider taking advantage of the new $5,000,000 ($10,000,000 total for both spouses) exemption by making lifetime gifts to their children and grandchildren during 2011 and 2012 (either outright transfers or in trust), leveraging gifts by utilizing family limited partnerships with discounted values, and using GRATs. Interests in a family-owned business can be gifted to family members tax free by utilizing valuation discounts and the new $5,000,000 exclusion.
1.2 Generation-skipping Tax (“GST”). For persons dying or for gifts made after December 31, 2009, the GST exemption increases to $5,000,000 (which means also a $5,000,000 GST tax exemption for gifts made in trust in 2010). The GST tax rate for transfers made in 2010 is zero percent. Accordingly, a $5,000,000 GST exemption can apply to trusts which were created during 2010. Thus, during 2010 and thereafter, “direct skips” (which are gifts to a grandchild or to a trust for the benefit of the grandchildren and younger generations) will automatically utilize the $5,000,000 GST exemption amount, unless the transferor elects otherwise on a filed gift tax return or estate tax return. For 2010, transfers to the grandchildren or their trust(s) in excess of the $5,000,000 exemption amount, no GST tax would be imposed upon such a direct skip. For the 2011 and 2012 years, the GST tax rate is 35%. Therefore, in 2010 there is no GST tax on gifts to grandchildren; and for 2011 and 2012 gifts, a husband and wife have a combined $10,000,000 GST exemption to make gifts to grandchildren.
1.3 Portability of Any Unused Estate Tax Exemption for Persons Dying After December 31, 2010 and Portability of Gift Tax Exemption. If a deceased spouse at death has not used up the full $5,000,000 dollars of their estate tax exemption, then that deceased spouse’s unused portion of their estate tax exemption can be transferred to their surviving spouse. Clients can use this portability of their estate tax exemption in order to avoid having to use a Bypass trust (a so-called “A-B Trust”) upon the death of the first-to-die spouse. Additionally, the surviving spouse can use the deceased spouse’s unused gift tax exemption in order for the surviving spouse to make greater amounts of tax-free gifts.
Planning Idea : Clients can utilize a disclaimer trust so that upon the death of the first-to-die spouse the surviving spouse can decide whether or not to disclaim a portion or all of the deceased spouse’s assets to a Bypass trust. The surviving spouse may still want to use a Bypass trust in order that the appreciation in the assets of the deceased spouse will remain exempt from federal estate tax. Furthermore, a Bypass trust allows using the first-to-die spouse’s $5,000,000 GST exclusion amount. A Bypass trust also serves a non-tax purpose of protecting trust remainder persons (such as children).
Because formula clauses in clients’ Wills and living trusts differ greatly, such clauses need to be carefully reviewed to verify that they continue to carry forth a client’s dispositive intentions. For example, with the increase in the estate tax exemption to $5,000,000, a client may not intend for this large $5,000,000 amount to go to the Bypass trust or to certain beneficiaries.
1.4 New Tax Law’s Effect on Estates of Persons Dying in 2010. For a person dying in 2010, their personal representative can elect to either: (i) have an estate tax apply based upon a $5,000,000 exemption and a 35% estate tax rate, and receive a full step-up in the income tax basis of their property; or (ii) elect to have no estate tax apply regardless of the size of the decedent’s estate and utilize the modified carry over income tax basis rules which existed prior to the enactment of the Tax Act.
Planning Idea: If the value of an estate of a person who died in 2010 is less than $5,000,000, the personal representative may wish to elect to have the estate tax (with a $5,000,000 exemption and 35% rate) apply in 2010, since the estate can utilize the $5,000,000 exemption to shelter the estate tax and receive a full step up in income tax basis of all of the assets. Electing in 2010 to have the estate tax apply may also be attractive for a surviving spouse because of the ability to use the unlimited marital deduction and still receive a full step-up in the properties’ income tax basis. On the other hand, if the first-to-die spouse died in 2010 and such first-to-die spouse has assets in excess of $5,000,000, it may be beneficial (depending on the deceased spouse’s Will or trust formula clause) to elect to treat the deceased spouse’s estate as if there was no estate tax so as to be able to allocate all of the deceased spouse’s assets to the Bypass trust (thus avoiding any future estate tax on the appreciation in the Bypass trust’s assets when the surviving spouse dies).
2. Continuing the Lower Income Tax Rates .
The Tax Act postpones the sunset rules for two years and allows the prior lower Bush-era income tax rates to remain in place. Thus, the highest individual income tax rate will remain at 35% (instead of 39.6%) for 2011 and 2012. Additionally, for 2011 and 2012, there is no reduction in itemized deductions and personal exemptions for higher income clients.
2.1 Long Term Capital Gain Rates and Qualified Dividend Tax Rates. These rates will remain at a maximum 15% rate through December 31, 2012.
Planning Idea: Clients thinking of selling their businesses, real estate, or other capital assets should take advantage of the low maximum 15% capital gain rate for 2011 and 2012, and consider not delaying the sale until after 2012.
2.2 The Alternative Minimum Tax (“AMT”). The AMT tax has been modified with a two-year patch as follows: the AMT exemption for individuals filing jointly is $72,450, with a phase out resulting in a zero dollar AMT exemption when alternative minimum taxable income reaches $439,800. The AMT exemption for unmarried individuals is $47,450, and for married individuals filing separately is $36,225 with these exemptions phased out for higher income clients.
3. Reduction in the Employee’s Share of Payroll Taxes .
The Tax Act provides a 2% reduction in employee’s share of payroll taxes and self-employment taxes for the year 2011. Thus, in 2011 employees will only pay a 4.2% social security tax on their wages, and self-employed individuals will pay only a 10.4% social security tax.
4. Increased Depreciation and Expensing of Capital Assets .
The Tax Act permits a much quicker write-off of capital investments as follows:
4.1 100% Deduction for Capital Investments. There is a 100% deduction for property eligible for bonus depreciation under §168(k) as to property acquired and placed in service after September 8, 2010 and prior to January 1, 2012 (with no limit as to the amount of this deduction). To qualify for this 100% first year depreciation, the property must be certain types of new property such as depreciable property with a recovery period of 20 years or less, computer software or qualified leasehold improvements. The original use of the property must commence with the taxpayer (thus, used equipment does not qualify under these new tax rules). A 50% bonus first year depreciation is available for property placed in service afte r December 31, 2011, and before January 1, 2013. Note that California is not likely to conform to these new federal bonus depreciation rules, considering the current California State budget deficit.
Planning Idea: Businesses can take advantage of these new tax provisions by acquiring equipment, furniture, and machinery during 2011 to achieve the 100% bonus depreciation deduction. Buyers of real estate can take advantage of these provisions through cost segregation studies (whereby a portion of the real estate is reclassified as personal property). Additionally, these rules allow landlords and tenants for 2011 to expense qualified leasehold improvements made to buildings.
4.2 The §179 expensing rules are modified for tax years beginning after December 31, 2011 so that the maximum expensing amount under §179 is now $125,000 of capital expenditures (indexed for inflation). This ability to expense capital items begins to be phased out once the client’s capital expenditures exceed $500,000 (indexed for inflation). Computer software purchased off the shelf will qualify for the §179 expensing if it is placed in service before 2013.
5. Charitable Rollovers .
Individuals 70½ years or older can make tax-free distributions during 2010 and 2011 to qualified charities from an IRA account of up to $100,000 per taxable year. Individuals will be allowed to treat IRA transfers made during January 2011 to qualified charities as being made during 2010.
Planning Idea: Taxpayers who are subject to the charitable percentage limitation deductions based upon their adjusted gross income will find this provision advantageous since they will not have to include in their adjusted gross income the rollover amount going to charity, and thus avoid the charitable deduction percentage limitations.
6. Other Business Tax Incentives .
The Tax Act extends the following tax incentives: the research credit; the §181 deduction of certain motion picture and television productions; the 15-year write-off for qualified leasehold improvements, restaurant buildings and improvements, and retail improvements; the seven-year amortization period for motor sports and entertainment facilities; allowance to expense environmental remediation costs; and the adjustment to the income tax basis of S corporation stock where the S corporation makes charitable contributions.
IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with Treasury Department regulations, we inform you that any U.S. Federal tax advice contained in this Newsletter is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
 Also, the $13,000 per donee annual gift tax exclusion continues to apply (or $26,000 for a husband and wife gifting community property) per person, as adjusted in the future for inflation. Additionally, tax-free gifts may be made for tuition and medical care.
 There were previous Congressional proposals to limit application of minority and lackof marketability discounts and to require GRATs to be at least 10 years, but none of those tax provisions were made part of the Tax Act.
 The official Federal interest rates remain low, thus favoring transfer to GRATs and sales of assets to grantor trusts (sometimes referred to as “defective income trusts”). In January 2011, the federal interest rates for GRATs was a low 2.4% and the interest rate was 1.95% for promissory notes not longer than nine years.
 Making gifts in 2011 and 2012 avoids the risk that in 2013 the exclusion will revert back to $1,000,000 and the tax rate increases to 55%. However, for political and tax policy reasons, it is unlikely Congress would consider imposing a retroactive $1,000,000 gift tax exclusion or a retroactive 55% tax rate.
 Only the unused estate tax exemption of the last spouse to whom the second to die spouse was married to can be used by the second to die spouse under this new portability rule (in other words, a “LIFO rule” applies).
 The election to have this portability of the unused exclusion is made on the estate tax return of the first spouse to die .
 Note that the $5,000,000 GST exclusion amount is not portable between spouses.
 For clients dying in 2010, if the tax regime is elected to treat the estate tax as being repealed (and there being no estate tax), there will only be a limited step up in the income tax basis of the assets, resulting in potential capital gain tax when the surviving spouse sells such assets (however, such capital gains tax will likely be delayed and will probably be at a lower rate than would be the 35% estate tax rate). In order for the “estate tax repeal election” to apply for decedent’s dying in 2010, the decedent’s personal representative must make an affirmative tax election.
 There is an exception for a 28% rate on gain from the sale of collectibles and a 25% rate on unrecaptured Section 1250 gain.
 Under the tax law for 2010, there was a 6.2% social security tax on wages up to a tax base (which tax base is $106,800 for 2011) and a self-employed tax of 12.4% on self-employment income up to this base amount. Thus, the Tax Act’s employment tax reduction equals a $2,136 tax savings.
 Qualified leasehold improvements exclude : enlargement of a building, elevators and escalators, structural components of common areas, and internal structural framework of the building. Also, to be qualified leasehold improvements, the improvements may not be placed in service three years or sooner after the building was first placed in service.