This Will Impact Your Wallet - Tax Changes Proposed in Obama 2012 Budget

President Obama’s fiscal year 2013 budget has the potential to trim the deficit by Four Trillion ($4,000,000,000,000.00) Dollars through a combination of spending cuts and tax increases. These proposals will effect all taxpayers, but have particular impact to top earnings, business owners, and those with asset in excess of $5 million.  

President Obama unveiled his fiscal year 2013 budget on February 13, 2012 amidst a cloud of uncertainty relating to Bush era tax cuts and the more immediate the fate of the payroll tax cuts (which news channels advise are to be extended later today). President Obama’s fiscal year 2013 budget proposals incorporate initiatives from his “Blueprint for America” as described in his 2012 State of the Union address. While some of the President’s proposals were immediately rejected by the GOP, others could move along quite quickly. The expected extension of the Employee Side Payroll Tax Cut could serve as a vehicle to move some of the proposals, such as an extension to the 100% bonus depreciation.

What you will find striking in the summary outlining the budget proposal is the effect directly on individuals and businesses. The most significant issue are:

  • Reinstatement of the top individual income tax rates at the 36% and 36.9% tax brackets
  • Reinstatement of  the personal exemption phase out/limitation of itemized deductions for taxpayers earning more than $200,000 a year for individuals or joint returns with incomes over $250,000
  • Return of a $ 1million lifetime gift tax exemption
  • Capping the federal estate tax and generation skipping tax exemptions at $3.5 million per person (with portability between spouses)

Click here for a complete summary.

 

Make Large Gifts Now, Pay More Tax Later?

If you make big gifts in 2011-2012, what happens when you die in 2013 and beyond?

Right now, and continuing through 2012, there is a gift tax/estate tax/GST exemption amount of $5,000,000 per person. We have discussed before what a fantastic opportunity this can be for wealthy families to do transfers at little or no transfer tax.

However, for every action, there is also a reaction. One thing that is not being talked about, and that families need to be aware of, is: What are the consequences of making a large gift utilizing the $5,000,000 exemption amount, in the event that the estate tax exemption amount upon your death is lower (such as $1,000,000) and what impact this might have on your New Jersey estate taxes.  This problem is sometime referred to as the "Clawback" (no, I did not make that up).

All of this stems from the little known or understood fact that “prior taxable gifts” are added to a person’s taxable estate to determine their federal estate tax liability. Since New Jersey relies on the Federal estate tax liability scheme as it existed in 2001 to determine its estate taxes, the Clawback issue is particularly dear to New Jersey residents.

When making a gift using your gift tax exemption, it is generally explained that you use it now or you use it later. For example, if you make a gift of $2,000,000 during your lifetime, and the estate tax exemption amount was $5,000,000 on your death, you would effectively have $3,000,000 of your exemption left. However, the way that is calculated is you have $6,000,000, you gave away $2,000,000 (leaving a $4,000,000 estate, which is less than the $5,000,000 exemption amount) and you die. Your prior $2,000,000 gift is added back to your taxable estate of $4,000,000, creating the same $6,000,000 taxable estate, the $5,000,000 is applied to the estate, and in my example, you have $1,000,000 upon which the estate tax may be levied.

The problem? What happens if the estate tax exemption amount is less upon your death. Going back to the example above, you had a $6,000,000, you gave away $2,000,000 so that you have a $4,000,000 estate upon your death. You add back in the $2,000,000 to create a $6,000,000 taxable estate, but you only have a $1,000,000 exemption amount. In this situation, your taxes are being levied on a $5,000,000 taxable estate ($6 million less $1 million exemption), but in reality, there are only $4,000,000 of assets actually in your estate, because you had added back this theoretical $2,000,000 that you had already given away.

For New Jersey purposes, this situation can be even worse. That is because New Jersey has such a low estate tax threshold of $675,000. Theoretically, you could have had $5,100,000, and given away $5,000,000. For New Jersey estate tax purposes, the $5,000,000 "prior taxable gift" is added back in to your taxable estate, and the New Jersey estate tax is calculated on the combined amount.  The New Jersey estate tax is somewhere in the vicinity of $350,000, but the only assets that you actually have are $100,000.

So when considering gifting to take advantage of the 2011/2012 transfer tax sale, thought must be given to what happens after the sale is over – will so much of your estate be potentially subject  to taxes if there is a lower estate tax rate (or if you are in New Jersey) that making a gift now precludes you from making other distributions upon your death?
 

Thanks to Steven A. Loeb, Esq. for his insights for this article.

Photo © Mark Rasmussen | Dreamstime.com

Transfer Taxes on Sale - Video Overview

First, we're trying something new here and have created a video overview the 2011-2012 Tax Sale on Gift Taxes, Estate Taxes, and Generation Skipping Taxes.  For wealthy individuals this is an unprecedented opportunity to transfer that wealth to other generations at little or no tax costs.  

While our video aims to educate you about why these tax law changes can have a real dollar impact on a family, take a quick look at the tax law changes:

Estate, Gift and Generation Skipping Tax
Transfer Tax 2009 2011-2012 2013+
Estate Tax

* $3.5 Million Exemption

* Max 55% Tax Rate

* $5 Million Exemption

* Max 35% Tax Rate

* $1 Million Exemption

* Max 55% Tax Rate

Gift Tax

* $1 Million Exemption

* Max 55% Tax Rate

* $5 Million Exemption

* Max 35% Tax Rate

* $1 Million Exemption

* Max 55% Tax Rate

GST Tax

* $3.5 Million Exemption

* Max 55% Tax Rate

* $5 Million Exemption

* Max 35% Tax Rate

* $1 Million Exemption

* Max 55% Tax Rate

In short, you can make a tax free gift of 5 times more assets in 2011-2012 than you could in 2009, or will be able to in 2013.  This is truly a limited opportunity for people to cut Uncle Sam out of their estate plan.

Is video a good medium to discuss these topics?  Does the PowerPoint add or take away from the information?  Does video make tax law more accessible?  Feedback is appreciated!

What does the New Tax Law mean for New Jersey?

I wouldn’t have taken bets on it, but Washington has hammered out how our federal tax laws are going to look for the next 2 years. On the plus side, we know what taxes are going to look like in January 2011, which is a far better place to be than Monday of last week. On the downside, this does not represent thoughtful tax reform – instead, it is knee-jerk politicking with the intent to dump the tax issues in the voters' laps at the next election so no politician is "responsible" for having taxes go up.

The cost of this package? $858,000,000,000.00 added to the federal deficit- yeah, that's a big number. Oh, and "added to the federal deficit” really just means that we spent $858,000,000,000.00 that we don't have. What I'd like to see happen in the new year – an actual bi-partisan examination of how tax policy affects the economy, and a roadmap to create a balance between the amount that we are spending, and the amount of revenue being generated.

To get back to the new law, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ("TRA") extends many tax cuts that were going to expire on December 31, 2010, as well as throws in some new tax laws. Some highlights:

  • The maximum federal income tax rate will remain at 35%. New Jersey income taxes are an additional maximum 8.97%
  • Married couples will continue to benefit from the 200% standard deduction
  • High income taxpayers will not be subject to phase-out of itemized deductions and personal exemptions for high-income taxpayers
  • Most key - "Patch" of alternative minimum tax exemption to keep rate with inflation (this is a law they should really make permanent)
  • Capital gains and dividends will continue to be taxed at 15%. New Jersey income taxes are an additional maximum 8.97%
  • The federal estate tax returns with a portable exemption of $5 million per person and a maximum tax rate of 35% (more to follow). New Jersey’s exemption rate continues to be $675,000 per person and is not portable.
  • The greatest opportunity is created in the increase of the gift tax exemption and generation skipping tax exemption to $5 million per person at a 35% maximum rate. New Jersey does not have a gift tax.
  • Extension of unemployment benefits for 13 months
  • Employees will benefit from a 2% reduction in Social Security withholding
  • Business owners can depreciate 100% of new business assets placed in service before January 1, 2012

My thanks to Sobel & Co for their excellent TRA summary, which I used as a resource.

 

Proposed Estate Tax Legislation Contains some Generous Surprises

The new estate tax legislation proposed by Sen. Reid (D. NV) contains some pleasant surprises for wealthier Individuals.

First, as expected, it proposes to raise the estate tax exemption amount to $5 million per person with a maximum 35% estate tax rate for the next 2 years.

Additionally, the proposed legislation is retroactive to January 1, 2010, so that the estates of people who died in 2010 can select the new 2011 law, or the basis allocation law that has been in place during this year.

Most unexpected,the new law also proposes a 2 -year window where there is a $5 million gift tax exemption per person, with a gift tax rate of 35%. There would similarly be a $5 million Generation Skipping Tax exemption.This could give individuals a huge planning opportunity to transfer assets with great growth or income potential to the next-generation at little or no transfer tax cost.

And now we wait to see what happens next…

Year End Sale on Gift Tax - The Fine Print

That's right - the gift tax is on sale this year, but the opportunity is closing fast.  You have until December 31, 2010 to act on the biggest gift tax sale I have seen in my years of practice.  But what is the fine print?

  • Each person has a $1 million exemption from gift tax for gifts during their lifetime in excess of the annual exclusion amounts of $13,000 per gift recipient per year. 

 

  • In 2010 only, gifts over $1 million are taxed at 35%.  In 2009 the tax rate was 45% and its scheduled to go up to a maximum rate of 55% in 2011. 

 

  • There is no generation skipping tax on gifts made to grandchildren (or further generations) in 2010.  This creates an opportunity to shift wealth from grandma to grand-kids and leave Uncle Sam out in the cold.

So who is this sale targeted at?  Families where the oldest generation is "set" financially and can afford to give away dollars now, their children are already independently successful and don't "need" mom and dad's money, and the family goal is to maximize the amounts distributed to future generations.

Many families are surprised at the wealth of the oldest generation - those "old fashioned" values of saving dollars, deferred gratification and not buying things you can't afford has lead to large amounts of wealth.  The one year only gift tax sale is worth a family conversation over Thanksgiving to see if planning can be done now to reach the family's goals at a much lower cost. 

Image: Salvatore Vuono / FreeDigitalPhotos.net

5 Reasons to Think About Making Gifts in 2010

I came across this great summary of 5 reasons to consider making gifts in 2010 by Marilyn J. Maag through Lexis Nexis Estate Practice & Elder Law Community (I follow them on Twitter).

  1. Changes in tax rates - the gift tax rate is scheduled to go up from 35% to 60% in 2011 unless Congress acts
  2. Low asset values - particularly for real estate and family businesses
  3. Low applicable federal interest rates - make techniques such as Grantor Retained Annuity Trusts (GRAT) more successful
  4. Restrictions on Intra-Family Transfers - may become law next year
  5. Valuation Discounts - may be going away

Image: Francesco Marino / FreeDigitalPhotos.net

No Estate Tax in 2010 - What Opportunities Might there be?

 My two prior posts have been about the  federal tax impact for single individuals who die in 2010, and the federal tax impact for married individuals.  In summary the results for singles were not good, and for marrieds were worse – the "death" of the estate tax creates a capital gains "trap" for survivors.  While all this will be moot if Congress does as they have promised and create an estate tax retroactive to January 1, 2010, they haven’t acted yet, and as of January 1, this is the law.

What planning can be done in this environment?

Can you just say “whoo-hoo”; I’ll give everything to my children.  Hold on there – the federal estate tax is repealed in 2010, not the federal gift tax.  Each person still has a lifetime exemption of $1,000,000 – if you make gifts in excess of that in 2010, you will be subject to the federal gift tax at a rate of 35%.

However, the generation skipping tax (“GST tax”) is repealed in 2010.  The GST Tax essentially says that you can only leave up to $3.5 million to grandchildren without paying a separate tax of 55%.  The theory behind the GST Tax is that the government should share in the wealth at each generation.  If grandma leaves everything to granddaughter, the IRS might need to wait 75 years until tax can be collected again.  If assets go the children, the IRS might only have to wait 30 years to tax again.  So, in 2009 you could leave up to $3.5 million to grandchildren without GST tax. In 2010, you can leave everything to grandchildren without an additional tax.  For wealthy families, this could mean a huge amount passing to lineal descendants with the only tax cost(s) being capital gains (click here for an explanation of the 2010 capital gains tax trap for estates).

The estate plan you had in 2009 and will need again in 2011 won’t really make sense in 2010 unless they make the estate tax retroactive.  Do you need to go out and totally revise your plan? Not necessarily.  If you have a terminal situation however, it definitely bears looking at your current plan to make sure it addresses how to plan to minimize capital gains taxes instead of estate taxes.

Gifts to grandchildren may be a winning strategy in early 2010.  Also, for anyone who is terminally ill, a change of an estate plan to leave assets to grandchildren may be a winner as well (although if the estate plan isn’t changed, disclaimers may be able to be employed by the children to a similar effect).  And it will bear looking at the estate plan of anyone who is terminally ill.

 

Image: Danilo Rizzuti / FreeDigitalPhotos.net