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By Editor, February 15, 2012

President’s FY 2013 budget proposals carry numerous tax changes

On February 13, the President released his federal budget proposals for fiscal year 2013, and, on the same day, the Treasury released its “General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals” (the so-called “Green Book”). The revenue proposals include over 130 large and small proposed tax changes for businesses and individuals, including new incentives to “insource” jobs, higher taxes for upper-income taxpayers, and the extension of key tax breaks. Here is a run down of the domestic tax proposals.

Business Tax Proposals

The budget’s proposals for business include the following.

• FICA Cut Extended.The payroll tax cut currently in place for January and February of this year would be extended for the rest of 2012.
• Wage Credit.Qualified employers would be provided a tax credit for increases in wage expense, whether driven by new hires, increased wages, or both. The credit would be equal to 10% of the increase in the employer’s 2012 eligible wages (OASDI wages) over the prior year (2011). The maximum amount of the increase in eligible wages would be $5 million per employer, for a maximum credit of $500,000, to focus the benefit on small businesses. For employers with no OASDI wages in 2011, eligible wages for 2011 would be 80% of their OASDI wage base for 2012. The credit would generally be considered a general business credit. A similar credit would be provided for qualified tax-exempt employers. The credit would be effective for wages paid during the one-year period beginning on Jan. 1, 2012.
• FUTA.Employers currently pay FUTA tax at a rate of 6.0% (beginning July 1, 2011) on the first $7,000 of covered wages paid annually to each employee. The rate for the first half of 2011 was 6.2%, including the 6% permanent tax rate and the 0.2% temporary surtax that expired on June 30, 2011. The net federal unemployment insurance tax on employers would permanently revert to 6.2%, effective for wages paid with respect to employment on or after Jan. 1, 2013. Also, under current law, employers in States that meet certain Federal requirements are allowed a credit against FUTA taxes of up to 5.4%, making the minimum net Federal rate 0.6%. States that become non-compliant are subject to a reduction in FUTA credit, causing employers to face a higher Federal UI tax. Effective on the enactment date, short-term relief would be provided, for example, the FUTA credit reduction for employers in borrowing States would be suspended in 2012 and 2013. Other changes would be made. For example, the FUTA wage base would be raised in 2015 to $15,000 per worker.
• Bonus Depreciation.  The 100% bonus first-year depreciation deduction that generally applies only for assets placed in service before 2012, would be extended through 2012.
• LIFO Repeal.  Use of the last-in, first-out (LIFO) accounting method would be repealed, for tax years beginning after Dec. 31, 2013. Taxpayers required to change from the LIFO method also would be required to report their beginning-of-year inventory at its first-in, first-out (FIFO) value in the year of change, causing a one-time increase in taxable income that would be recognized ratably over 10 years.
• Lower of Cost or Market Repeal.  For tax years beginning after Dec. 31, 2013, bar the use of the lower-of-cost-or market and subnormal goods methods of inventory accounting, which currently allow certain taxpayers to take cost-of-goods-sold deductions on certain merchandise before the merchandise is sold. Any resulting income inclusion would be recognized over a four-year period beginning with the change year.
• Energy Credits.  An additional $5 billion of credits for investments in eligible property used in a qualifying advanced energy manufacturing project. Taxpayers would be able to apply for a credit with respect to part or all of their qualified investment. Applications for the additional credits would be made during the two-year period beginning on the date on which the additional authorization is enacted.
• More Energy Credits.  Replace the existing deduction for energy efficient commercial building property with a tax credit equal to the cost of property that is certified as being installed as part of a plan designed to reduce the total annual energy and power costs with respect to the interior lighting, heating, cooling, ventilation, and hot water systems of the building by 20% or more in comparison to a reference building which meets certain minimum requirements. The tax credit would be available for property placed in service during calendar year 2013.
• Build America Bonds.Effective for bonds issued after the enactment date, make the Build America Bonds program permanent at a Federal subsidy level equal to 30% through 2013 and 28% of the coupon interest on the bonds thereafter. The 28% Federal subsidy level would be intended to be approximately revenue neutral relative to the estimated future Federal tax expenditure for tax-exempt bonds. The eligible uses for Build America Bonds also would be expanded.
• IRAs.Effective after 2013, require employers in business for at least two years that have more than ten employees to offer an automatic IRA option to employees, under which regular contributions would be made to an IRA on a payroll-deduction basis. If the employer sponsored a qualified retirement plan, SEP, or SIMPLE for its employees, it would not be required to provide an automatic IRA option for its employees. Additionally, the non-refundable “start-up costs” tax credit for a small employer that adopts a new qualified retirement, SEP, or SIMPLE would be doubled from the current maximum of $500 per year for three years to a maximum of $1,000 per year for three years and extended to four years (rather than three) for any employer that adopts a new qualified retirement plan, SEP, or SIMPLE during the three years beginning when it first offers (or first is required to offer) an automatic IRA arrangement. This expanded “start-up costs” credit for small employers, like the current “start-up costs” credit, would not apply to automatic or other payroll deduction IRAs.
• Qualified Small Business Stock.  For qualified small business stock (QSBS) acquired after Dec. 31, 2011, make the 100% exclusion for qualified small business stock permanent. The AMT preference item for gain excluded under Code Sec. 1202 would be repealed for all excluded small business stock gain. Also, the time for a taxpayer to reinvest the proceeds of sales of small business stock under Code Sec. 1045 would be increased to 6 months for qualified small business stock the taxpayer has held longer than three years.
• Start-up Expenditures.  For tax years ending on or after the date of enactment, the maximum amount of start-up expenditures that a taxpayer may deduct (in addition to amortized amounts) in the tax year in which a trade or business begins, would be permanently doubled from $5,000 to $10,000. This maximum amount of expensed start-up expenditures would be reduced (but not below zero) by the amount by which start-up expenditures with respect to the active trade or business exceed $60,000.
• Health Insurance Tax Credit.  For tax years beginning after Dec. 31, 2011, liberalize the tax credit available to small employers providing health insurance to employees. For example, the group of employers who are eligible for the credit would be expanded to include employers with up to 50 full-time equivalent employees and the phase-out would begin at 20 full-time equivalent employees.
• Jet Depreciation.  Require corporate business jets that carry passengers to be depreciated over seven years instead of five, effective for property placed in service after Dec. 31, 2012.
• Oil and Gas Tax Preferences.  Eliminate these tax preferences for oil and gas companies, generally effective after Dec. 31, 2012: investment tax credit for enhanced oil recovery projects, production credit for oil and gas from marginal wells, intangible drilling cost deduction, the deduction for tertiary injectants used as part of a tertiary recovery method, the exception to passive loss limits for working interests in oil and natural gas properties, percentage depletion, and two-year amortization of independent producers’ geological and geophysical expenditures (amortization period would be increased to seven years).
• Coal Activity Tax Prefernces.  Eliminate tax preferences for coal activities beginning in 2013 (expensing of exploration and development costs, percentage depletion for hard mineral fossil fuels, capital gains treatment for royalties, and the Code Sec. 199 deduction).
• Tax Carried Interests.  Tax certain “carried interest” as ordinary income, instead of at the 15% capital gains rate.
• Worker Classification.  Permit IRS to issue generally applicable guidance about the proper classification of workers and to require prospective reclassification of workers who are currently misclassified and whose reclassification is prohibited under section 530 of the ’78 Revenue Act. Penalties would be waived for service recipients with only a small number of workers, if they had consistently filed all required information returns reporting all payments to all misclassified workers and agreed to prospective reclassification of misclassified workers. This proposal would apply on enactment, but the prospective reclassification for those covered currently by section 530 of the ’78 Revenue Act would not be effective for at least one year after the enactment date.

Proposals to Boost U.S. Manufacturing and Insourcing of Jobs

To encourage businesses to locate jobs and business activity in the U.S., the President’s budget proposes to make these changes, among others:

• “Buffet Rule”.  Replace the alternative minimum tax with a 30% tax minimum tax on people earning at least $1 million.
• New General Business Credit.  Effective for expenses paid or incurred after the date of enactment, create a new general business credit against income tax equal to 20% of the eligible expenses paid or incurred in connection with insourcing a U.S. trade or business. Insourcing a U.S. trade or business would mean reducing or eliminating a trade or business (or line of business) currently conducted outside the U.S. and starting up, expanding, or otherwise moving the same trade or business within the U.S., to the extent that this action results in an increase in U.S. jobs.
• Disallow Outsourcing Deductions.  Effective for expenses paid or incurred after the date of enactment, deductions for expenses paid or incurred in connection with outsourcing a U.S. trade or business would be disallowed. Outsourcing a U.S. trade or business would mean reducing or eliminating a trade or business or line of business currently conducted inside the U.S. and starting up, expanding, or otherwise moving the same trade or business outside the U.S., to the extent that this action results in a loss of U.S. jobs.
• Credit for Communities with Job LossesCreation of a new allocated tax credit to support investments in communities that have suffered a major job loss event (i.e., when a military base closes or a major employer closes or substantially reduces a facility or operating unit, resulting in a long-term mass layoff). About $2 billion in credits would be provided for qualified investments approved in each of the three years, 2012 through 2014.
• Cut Back Domestic Production Deduction.  For tax years beginning after Dec. 31, 2012, limit the extent to which the Code Sec. 199 domestic production deduction is allowed with respect to nonmanufacturing activities by excluding from the definition of domestic production gross receipts (DPGR) any gross receipts derived from sources such as the production of oil and gas, the production of coal and other hard mineral fossil fuels, and certain other nonmanufacturing activities. Additional revenue obtained from this retargeting would be used to increase the general deduction percentage and to fund an increase of the deduction rate for activities involving the manufacture of certain advanced technology property to approximately 18%.
• R&D Credit.  Retroactively effective after Dec. 31, 2011, make the research credit permanent and increase the rate of the alternative simplified research credit from 14% to 17%.

Tax Changes for Individuals

The President’s plan calls for numerous changes to be made for individuals, including the following:

• Reinstate Deduction Phase-outs.  For tax years beginning after Dec. 31, 2012, reinstatement of upper-income taxpayers’ reduction of itemized deductions and phaseout of personal exemptions.
• Bush era Tax Cuts.  The expiration of the 2001 and 2003 (EGTRRA and JGTRRA) tax cuts for those with household income over $250,000 a year for joint filers ($200,000 for single taxpayers), effective after 2012.
• Tax on Dividends.  For dividends received after Dec. 31, 2012, the current reduced tax rates on qualified dividends would expire for income that would be taxable in the 36% or 39.6% brackets. In other words, qualified dividends for upper income taxpayers would be taxed as ordinary income.
• Tax on Long-term Capital Gains.  For long-term capital gains realized after Dec. 31, 2012, the current reduced tax rates on long-term capital gains would expire for capital gain income that, in the absence of any preferential treatment of long-term capital gains, would be taxable in the 36% or 39.6% brackets. Thus, the maximum long-term capital gains tax rate for upper-income taxpayers would be 20%.
• Limit the Benefit of Deductions.  For tax years beginning after Dec. 31, 2012, the tax value of specified deductions or exclusions from AGI and all itemized deductions would be limited to 28% of the specified exclusions and deductions that would otherwise reduce taxable income in the 36% or 39.6% tax brackets. A similar limit also would apply under the alternative minimum tax. The limit would apply to tax-exempt state and local bond interest, employer-sponsored health insurance paid for by employers or with before-tax employee dollars, health insurance costs of self-employed individuals, employee contributions to defined contribution retirement plans and individual retirement arrangements, the deduction for income attributable to domestic production activities, certain trade and business deductions of employees, moving expenses, contributions to health savings accounts and Archer MSAs, interest on education loans, and certain higher education expenses. The change would apply to itemized deductions after they have been reduced by the proposed statutory limit on certain itemized deductions for higher income taxpayers.
• Education Credits.  The budget proposal would make permanent the American Opportunity Tax Credit (AOTC), a partially refundable tax credit worth up to $10,000 per student over four years of college.
• EITC Credit.  For tax years beginning after Dec. 31, 2012, the expansion of the EITC for workers with three or more qualifying children would be made permanent. Specifically, the phase-in rate of the EITC for workers with three or more qualifying children would be maintained at 45%, resulting in a higher maximum credit amount and a longer phase-out range.
• Child Care Credit.  For tax years beginning after Dec. 31, 2012, the AGI level at which the child and dependent care credit begins to phase down would permanently increase from $15,000 to $75,000. The percentage of expenses for which a credit may be taken would decrease at a rate of 1 percentage point for every $2,000 (or part thereof) of AGI over $75,000 until the percentage reached 20% (at incomes above $103,000).
• Principal Residence COD.  The exclusion for income from the discharge of qualified principal residence indebtedness (QRPI) would be extended to amounts that are discharged before Jan. 1, 2015, and to amounts that are discharged pursuant to an agreement entered before that date.

Estate and Gift Tax Proposals

Restoration of transfer tax to 2009 levels.The estate, generation-skipping transfer (GST), and gift tax parameters as they applied during 2009 would be made permanent. The top tax rate would be 45% and the exclusion amount would be $3.5 million for estate and GST taxes, and $1 million for gift taxes. These changes would apply for estates of decedents dying, and for transfers made, after Dec. 31, 2012.

Portable estate tax exclusion made permanent. The provision allowing a surviving spouse to use the deceased spouse’s unused estate tax exclusion, which expires for decedents dying after Dec. 31, 2012, would be made permanent.

Basis consistency and reporting requirement for donated and inherited property.The basis of property in the hands of the recipient could be no greater than the value of that property as determined for estate or gift tax purposes (subject to subsequent adjustments). A reporting requirement would be imposed on executors and donors to provide the necessary valuation and basis information to both the recipient and IRS. These rules would apply for transfers on or after the enactment date.

Toughened rules for valuation discounts.Certain additional restrictions (“disregarded restrictions”) would be ignored under Code Sec. 2704 in valuing an interest in a family-controlled entity transferred to a member of the family if, after the transfer, the restriction will lapse or may be removed by the transferor and/or the transferor’s family. The transferred interest would be valued by substituting for the disregarded restrictions certain assumptions to be specified in regs. These rules would apply to transfers after the enactment date of property subject to restrictions created after Oct. 8, 1990 (the effective date of Code Sec. 2704)

Minimum and maximum term for grantor retained annuity trusts (GRATs).A GRAT would be required to have a minimum term of ten years and a maximum term of the life expectancy of the annuitant plus ten years. Also, the remainder interest would have to have a value greater than zero at the time the interest is created and any decrease in the annuity during the GRAT term would be prohibited. These rules would apply to trusts created after the enactment date.

Duration of GST tax exemption limited.On the 90th anniversary of the creation of a trust, the GST exclusion allocated to the trust would terminate. This rule would apply to trusts created after the enactment date, and to the portion of a preexisting trust attributable to additions to such a trust made after that date.

Coordination of income and transfer tax rules applicable to grantor trusts.The current lack of coordination between the income and transfer tax rules applicable to a grantor trust creates opportunities to structure transactions between the deemed owner and the trust that can result in the transfer of significant wealth by the deemed owner without transfer tax consequences. New rules for grantor trusts would prevent this by: (1) including the assets of the trust in the grantors’ gross estate of that grantor for estate tax purposes, (2) subjecting to gift tax any distribution from the trust to one or more beneficiaries during the grantor’s life, and (3) subjecting to gift tax the remaining trust assets at any time during the grantor’s life if the grantor ceases to be treated as an owner of the trust for income tax purposes. These rules would apply for trusts created on or after the enactment date and with regard to any portion of a pre-enactment trust attributable to a contribution made on or after the enactment date.

Extension of estate tax lien on Code Sec. 6166 deferrals.The estate tax lien under Code Sec. 6324(a)(1) would be extended to apply throughout the Code Sec. 6166 deferral period, effective for estates of decedents dying on or after the effective date and for estates of decedents dying before the enactment date as to which the current law Code Sec. 6324(a)(1) lien period had not expired on the effective date.

Other Proposals

Many expiring provisions would be extended. The Administration proposes to extend a number of provisions that have expired or are scheduled to expire on or before Dec. 31, 2012. For example, the optional deduction for State and local general sales taxes, the deduction for qualified out-of-pocket classroom expenses, the deduction for qualified tuition and related expenses, the Subpart F “active financing” and “look-through” exceptions, and the modified recovery period for qualified leasehold, restaurant, and retail improvements, would be extended through Dec. 31, 2013.

Source: Research Institute of America.

If you have any questions regarding these tax developments, please contact your Warren Averett Wilson Price accountant.

Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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By Editor, January 19, 2012

The following is a summary of the many important tax developments that have occurred in the past three months that may affect you, your family, your investments, and your livelihood. Please call us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

Payroll tax cut temporarily extended. The Temporary Payroll Tax Cut Continuation Act of 2011 was enacted late last year. It temporarily extends the two percentage point payroll tax cut for employees, continuing the reduction of their Social Security tax withholding rate from 6.2% to 4.2% of wages paid through Feb. 29, 2012. Shortly after its passage, the IRS instructed employers to implement the new payroll tax rate as soon as possible in 2012 but not later than Jan. 31, 2012. The law also includes a “recapture” provision, which applies only to those employees who receive more than $18,350 in wages during the two-month period (i.e., two-twelfths of the 2012 wage base of $110,100). This provision imposes an additional income tax on these higher-income employees in an amount equal to 2% of the amount of wages they receive during the two-month period in excess of $18,350 (and not greater than $110,100). In addition, under the new law, the social security tax rate for a self-employed individual remains at 10.4%, for self-employment income of up to $18,350 (reduced by wages subject to the lower rate for 2012). Congress is going to try to negotiate a deal to extend the payroll tax cut for all of 2012. If a deal is struck to extend it for the full year, the recapture provision for employees would not apply.

Credit for hiring veterans extended and enhanced. A law enacted last November extended and enhanced a credit for hiring qualified veterans. Before the law was passed, the credit would have been available only if the qualified veteran were hired before Jan. 1, 2012, and only certain veterans were considered qualified veterans. The new law extends the credit for hiring qualified veterans, adds two new classes of veterans who are considered qualified veterans, increases the credit for hiring certain qualified veterans, “fast-tracks” the process for certifying that an individual is a qualified veteran, and provides tax-exempt employers with a credit against payroll tax for hiring qualified veterans. The credit amount varies depending on a number of factors. It can be as high as $9,600 for hiring a qualified disabled veteran. For an employer to qualify for the credit, the qualified veteran must begin work for the employer before Jan. 1, 2013 and other requirements must be met.

New rules for deducting or capitalizing tangible property costs. The IRS has issued new regulations for determining whether amounts paid to acquire, produce, or improve tangible property may be currently deducted as business expenses or must be capitalized. The regulations will affect virtually all taxpayers that acquire, produce, or improve tangible property. They are comprehensive, voluminous and virtually rewrite the rules in this area. For example, they provide detailed definitions of “materials and supplies” and “rotable and temporary spare parts” and prescribe new rules and elective de minimis and optional methods for handling their cost. They also have rules for differentiating between deductible repairs and capitalizable improvements, among many other items. The regulations generally are effective in tax years beginning after Dec. 31, 2011. However, to add to their complexity, some of the new rules in the regulations do not supersede prior IRS guidance.

New foreign asset reporting guidance and form. The IRS issued detailed guidance on the new law requiring individuals with an interest in a “specified foreign financial asset” during the tax year to attach a disclosure statement to their income tax return for any year in which the aggregate value of all such assets is greater than $50,000 (or a dollar amount higher than $50,000 as the IRS may prescribe). In addition, the IRS issued Form 8938 (Statement of Specified Foreign Financial Assets), which individual taxpayers will use starting in the 2012 tax filing season to report specified foreign financial assets for tax year 2011. The guidance consists of detailed temporary regulations. They define terms that apply for purposes of the reporting requirement; provide rules to determine if a specified individual must file a Form 8938 with their annual return; define what are specified foreign financial assets; detail what information needs to be reported; provide guidelines for valuing specified foreign financial assets; list exceptions to the reporting requirements; and describe the penalties that apply for failure to comply with the reporting requirements.

Standard mileage rates flat or lower. The optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) is 55.5¢ per each business mile traveled after 2011. For 2011, it was 55.5¢ for miles driven after June 30 and 51¢ per mile for miles driven before July 1. Further, the 2012 rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction is 23¢ per mile. For 2011, it was 23.5¢ for miles driven after June 30 and 19¢ per mile for miles driven before July 1.

New Form 8949 replaces Form 1040, Schedule D-1. Many transactions that, in previous years, would have been reported on Form 1040, Schedule D or D-1 must be reported on Form 8949 if they occurred in 2011. Specifically, a taxpayer uses Form 8949 to report:

• The sale or exchange of a capital asset not reported on another form or schedule,
• Gains from involuntary conversions (other than from casualty or theft) of capital assets not held for business or profit, and
• Nonbusiness bad debts.

The taxpayer uses Schedule D to figure the overall gain or loss from transactions reported on Form 8949 and to report capital gain distributions not reported directly on Form 1040, line 13, a capital loss carryover from 2010 to 2011, and certain specialized items.

Withholding requirement for government contractors repealed. A law enacted in 2005 was to have required the Federal government and the government of every state, political subdivision of a state, and instrumentality of a state or state subdivision (including multi-state agencies) making certain payments to a person providing any property or services (e.g., payments to a government contractor) to deduct and withhold 3% from that payment. Although the withholding requirement was originally set to apply to payments made after 2010, it was subsequently deferred to apply to payments made after 2012. A law enacted in November 2011 repealed the government contractor withholding requirement.

If you have any questions regarding these tax developments, please contact your Warren Averett Wilson Price Division accountant.

Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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By Editor, May 4, 2011

IRA owners and beneficiaries who have reached age 70 1/2 are permitted to make cash donations to IRS-approved public charities directly out of their IRAs. These so-called qualified charitable distributions, or QCDs, are federal-income-tax-free to you, but you get no itemized charitable write-off on Form 1040. That’s OK because the tax-free treatment of QCDs equates to an immediate 100% deduction without having to worry about restrictions that can delay itemized charitable write-offs. QCDs have other tax advantages too. Here is what you need to know.

QCD Basics

A QCD is a cash payment of an otherwise taxable distribution, by your IRA trustee, directly to a qualified public charity. The funds must be transferred directly from your IRA trustee to the charity. You cannot receive the funds yourself and then make the contribution to the charity. However, the IRA trustee can give you a check made out to the charity that you then deliver to the charity.

You cannot arrange for more than $100,000 of QCDs in any one year. If your spouse has IRAs, he or she has a separate $100,000 limitation. If you are the beneficiary of an IRA (as opposed to an account owner), you too are eligible for the QCD deal if you are at least age 70 1/2.

You must get and keep substantiation of the contribution from the charity. Also, you must not have received any benefit in return for making the contribution.

The QCD privilege is scheduled to expire at the end of this year, so if you want to take advantage of the idea, it is not too soon to start thinking about it.

Income Tax Benefits

QCDs are not included in your Adjusted Gross Income (AGI). This lowers the odds that you’ll be affected by various unfavorable AGI-based phase-out rules. In addition, you don’t have to worry about the 50%-of-AGI limitation that can delay itemized deductions for garden-variety cash donations to public charities.

QCDs count as a payouts for purposes of the Required Minimum Distribution (RMD) rules. Therefore, you can donate all or part of your 2011 RMD amount (up to the $100,000 limit on QCDs) and thereby convert taxable RMDs into tax-free QCDs.

Does the QCD Deal Work for You?

The QCD privilege is beneficial for seniors in the following circumstances:

• You don’t itemize deductions. Under the “normal” rules, only itemizers get any income tax benefit from charitable donations. Making QCDs will save taxes whether you itemize or not because neither you nor your heirs will ever have to pay income taxes on the donated amounts.
• Your itemized charitable donations would be delayed by the 50%-of-AGI limitation. Making QCDs will avoid this unfavorable limitation.
• You want to avoid being taxed on RMDs that you are forced to take from your IRAs. The QCD strategy does the trick while also allowing you to satisfy your charitable inclinations.

Conclusion

If you’re interested in taking advantage of the tax-saving QCD strategy for 2011, you will need to arrange with your IRA trustee for money to be paid out to one or more qualifying charities by year-end.

If you have questions about QCDs or want more information, your Wilson Price accountant.

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By Editor, December 21, 2010

The recently enacted “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010″ is a sweeping tax package that includes, among many other items, an extension of the Bush-era tax cuts for two years, estate tax relief, a two-year “patch” of the alternative minimum tax (AMT), a two-percentage-point cut in employee-paid payroll taxes and in self-employment tax for 2011, new incentives to invest in machinery and equipment, and a host of retroactively resuscitated and extended tax breaks for individuals and businesses. Here’s a look at the key elements of the package:

• The current income tax rates will be retained for two years (2011 and 2012), with a top rate of 35% on ordinary income and 15% on qualified dividends and long-term capital gains.
• Employees and self-employed workers will receive a reduction of two percentage points in Social Security payroll tax in 2011, bringing the rate down from 6.2% to 4.2% for employees, and from 12.4% to 10.4% for the self-employed.
• A two-year AMT “patch” for 2010 and 2011 will keep the AMT exemption near current levels and allow personal credits to offset AMT. Without the patch, an estimated 21 million additional taxpayers would have owed AMT for 2010.
• Key tax credits for working families that were enacted or expanded in the American Recovery and Reinvestment Act of 2009 will be retained. Specifically, the new law extends the $1,000 child tax credit and maintains its expanded refundability for two years, extends rules expanding the earned income credit for larger families and married couples, and extends the higher education tax credit (the American Opportunity tax credit) and its partial refundability for two years.
• Businesses can write off 100% of their equipment and machinery purchases, effective for property placed in service after September 8, 2010 and through December 31, 2011. For property placed in service in 2012, the new law provides for 50% additional first-year depreciation.
• Many of the “traditional” tax extenders are extended for two years, retroactively to 2010 and through the end of 2011. Among many others, the extended provisions include the election to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes; the $250 above-the-line deduction for certain expenses of elementary and secondary school teachers; and the research credit.
• After a one-year hiatus, the estate tax will be reinstated for 2011 and 2012, with a top rate of 35%. The exemption amount will be $5 million per individual in 2011 and will be indexed to inflation in following years. Estates of people who died in 2010 can choose to follow either 2010′s or 2011′s rules.
• Omitted from the new law: Repeal of a controversial expansion of Form 1099 reporting requirements.
• Also not included: Extension of the Build America Bonds program, which permits state and localities to issue federally-subsidized municipal bonds.

Return of the estate tax in the 2010 Tax Relief Act

The estates of wealthy individuals who died in 2010 didn’t pay any federal estate tax, but that situation is about to change. Under the recently enacted “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010,” the federal estate tax, which disappeared for 2010, springs back to life in 2011 and is imposed at the top rate of 35% of the estate’s value after the first $5 million.

New law

The new law brings back the estate tax, for 2011 and 2012 anyway. During 2011 and 2012, the top rate will be 35%. For 2011, the exemption amount will be $5 million per individual (indexed for inflation after 2011). At those levels, the vast majority of estates (all but an estimated 3,500 nationwide in 2011) will not be subject to any federal estate tax, and the tax will raise about $11.4 billion for the government. By way of comparison, the 55% tax with a $1 million exemption would have resulted in about 43,540 taxable estates in 2011, and raised about $34.4 billion. Tax historians would also note that except for the temporary repeal of the estate tax in 2010, the estate tax rate has not been less than 45% since 1931.

The new law also gives heirs of decedents dying in 2010 a choice of which estate-tax rules to apply – 2010′s or 2011′s. That’s important because although there is no estate tax in 2010, some inherited assets are subject to higher capital gains tax under the 2010 rules, a situation that actually raises the tax burden for some heirs. Inherited assets under the 2010 rules have a tax basis equal to the price when they were purchased (referred to in tax parlance as “carryover basis”) rather than the price at death. That could lead to a significant tax burden for heirs who sell assets such as stocks that had been held for many years and have greatly appreciated in value. Under the 2011 rules, by contrast, heirs will be allowed to inherit assets with a “stepped-up basis.” While most heirs would choose the 2011 regime ($5 million exemption from both estate and generation-skipping tax and an unlimited step-up in the basis of assets to their current market value), the heirs of superrich decedents could find it more advantageous to elect the 2010 law (limited step-up in the basis of assets and no estate tax). If the executor makes the election to have the 2010 rules apply, the estate tax return’s due date will not be earlier than the date that’s nine months after the new law’s enactment date.

For gifts made after December 31, 2010, the gift tax will be reunified with the estate tax. Under the new law, the estate and gift tax exemptions will be reunified starting in 2011, which means that the $5 million estate tax exemption will also be available for gifts. The law in effect prior to 2010 provided a $3.5 million lifetime exemption for estates, but only $1 million for gifts. The gift tax rate, starting in 2011, will be 35%. The exemption from the generation-skipping tax (GST) – the additional tax on gifts and bequests to grandchildren when their parents are still alive – will also rise to $5 million from the $1 million it would have been without the new law. The GST tax rate for transfers made in 2011 and 2012 will be 35%.

From a planning standpoint, a nice feature of the new law is that it makes it easier to transfer the $5 million exemption to a surviving spouse, so married couples can shield $10 million of their assets from taxes. In the language of tax professionals, the estate tax exemption will be “portable.”

We hope this information is helpful. If you would like more details about the estate tax or any other aspect of the new law, please do not hesitate to call or email anyone here at Wilson Price CPAs and Consultants.

Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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By Editor, November 10, 2010

The IRS has still not finalized the form executors will use to report and allocate the basis of property received from a decedent in 2010.

We do know for certain, however, that a lot of information will be required for this filing.

Required Reporting

If you are an executor of a 2010 decedent, you will be required to file an informational return with the decedent’s final income tax return if:

The fair market value of all property (other than cash) exceeds $1,300,000 or

• The decedent transferred assets by gift or other lifetime transfer for which a gift tax return was required within the three year period preceding the decedent’s death

Note: if the decedent was a Nonresident, noncitizen of the United States, the filing is required if property situated in the United States exceeds $60,000

Information needed for preparation of the form

The form will be due April 15, 2011 along with the decedents final FORM 1040 return, with extensions permitted.  Executors will need to gather the following information to assist in preparation of the form.

• The decedent’s death certificate
• Marital status of the decedent
• Legal domicile and year domicile established
• Executor name, address and social security number
• Full name and social security number for surviving spouse
• Full name and social security number for all other beneficiaries
• Certified copy of decedent’s will
• Copy of decedent’s most recently filed individual income tax return
• A list of all assets owned by the decedent, solely and jointly with others, including:
  • A description of the asset
  • Date decedent acquired the asset
  • Indication if asset was acquired by gift
  • Adjusted basis of the asset at decedent’s date of death
  • Fair market value of the assets at decedent’s date of death
  • Indication if any gain in the asset would be an ordinary gain

Written statement to beneficiaries

After filing the informational form, executors will have 30 days to provide to each beneficiary a written statement that includes the information reported with respect to the property that the beneficiary acquired from the decedent. Failure to provide each beneficiary with this statement could result in a penalty of $50 for each failure.

Allocation of basis

In this year of estate tax repeal, the basis “step-up” rules do not apply.  Instead, basis of assets received from a decedent is the lesser of (1) the adjusted basis of the property at the decedent’s date of death or (2) the fair market value of the property at the decedent’s date of death.  Thus, a “step-down” is a possibility.  The law provides, however, basis increases for certain property.  The allocation of basis increases will be reported on the same form above.

General basis adjustment - a basis adjustment increase is allowed for any property acquired from a decedent for up to $1.3 million.  The executor will allocate this amount among the unrealized gains of the assets of the estate, as seen appropriate.

Additional basis adjustment – an additional increase of up to $3 million can also be applied to qualified spousal property, which would include property transferred to the spouse outright or to a QTIP trust where the spouse has a qualified income interest for life. 

Increases to basis adjustment amounts – if the decedent had any losses, such as capital loss carryforwards, net operating loss carryforwards, or certain built-in losses in 2010, these amounts could increase the general basis adjustment by the amount of the losses.  Additionally, if any assets received a “step-down” in the basis allocation process, the general basis adjustment of $1.3 million would be increased by that amount as well, thus keeping the aggregate increase in values at $1.3 million.

Property ownership

The basis increase adjustments cannot be allocated to property not owned by the decedent at death, which might be questionable in certain situations that are specifically addressed in the code.

Owned by decedent – property transferred by the decedent to a qualified revocable trust is considered to be owned by the decedent.  Additionally, if the decedent has at least one-half interest in community property, then for purposes of fulfilling the ownership requirement, this asset is considered 100% owned.

Not owned by decedent – the decedent is not considered to own property by means of holding a power of appointment over such property.

Partially owned by decedent:

• Jointly owned with surviving spouse – the decedent is considered to be owner of one-half of the property.          
• Jointly owned with someone other than spouse – the decedent is considered owning a percentage proportionate to the consideration provided.
• Jointly owned with someone other than spouse and was acquired by gift, bequest or inheritance – if parties interests are not otherwise fixed, the decedent is considered to own a percentage equal to one over the number of tenants.

Other information

There are additional provisions that should be considered:

• If the decedent is a nonresident, noncitizen of the United States, the basis increase adjustment is limited to $60,000
• IRAs, retirement plan benefits and other items of income in respect of a decedent (IRD) are not eligible for the basis increase adjustment
• Property acquired by the decedent by gift or other intervivos transfers for less than adequate consideration during the three year period preceding the date of death are not eligible for the basis increase adjustment

Penalties

Failure to report information to the IRS regarding an estate valued over $1.3 million or for certain transfers made within three years of death, will subject the executor to a penalty of $10,000. If the failure to report was an intentional disregard of the rules, the penalty could be as much as 5% of the fair market value of the property for which reporting was required.

So where is the form?

An unofficial draft (FORM 8939) has been circulating amongst professionals, but has not been officially released by the IRS.  IRS representatives say the official draft will be released to the public on their website, www.irs.gov. 

Please contact us if we can help you navigate through the administration of a 2010 estate.

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By Editor, November 10, 2010

From an estate planning perspective, these two 2010 opportunities make perfect sense on paper for many clients.  Both strategies, with proper planning, can save these taxpayers and their heirs a significant amount in estate taxes and income taxes.  However, most people are not eager enough to pay Uncle Sam any earlier than they have to, and the fear of uncertainty in estate tax laws brings only further hesitation.

The following thoughts may add appeal and ease fears…

MAKING THE MATH MORE APPEALING

If coming out of pocket now on the taxes is where you draw the line, consider adding life insurance to the equation.  It is common practice to include life insurance in an estate plan to add liquidity to pay estate taxes and expenses or to replace wealth given to charities.  The same methodology can apply here when considering making a taxable gift or paying income taxes on Roth conversion income.  Even though you are coming out of pocket now, you are reducing your estate by the income taxes paid and you can replace the wealth outside of your estate with a life insurance plan and life insurance trust. 

GIFTING

The gift tax is not an issue until you have exhausted your $1 million gift tax exemption.  The law also allows you to make annual exclusion gifts (free of gift tax) of up to $13,000.  Additionally, you can make an unlimited amount of payments for tuition or medical expenses directly to providers without incurring a gift tax.  If you have not used up your gift tax exemption, 2010 is an optimal time to do so, as asset values are depressed, interest rates are low, and valuation discounts are still available.  These factors allow you to maximize the amount of future value that you transfer.

Note: If you have made taxable gifts in previous years in excess of $500,000 but less than $1 million, you have already used up part of your unified credit based on higher tax rates.  As a result, you may not be able to gift the full balance of the $1 million without paying gift tax.

If you have used up your lifetime gift tax exemption, the potential for transfer tax savings by making taxable gifts in 2010 are even more significant than they may appear at first glance.  The gift tax rate is 35%, which is the lowest it has been since the 1930’s, but if you do the math, the effective rate is really less than 26% when compared to the estate tax.  Here is a general example:

Assume an individual would like to reduce his estate by $5,000,000 in 2010.  He makes a taxable gift of $3,703,704, paying 35% gift tax of $1,296,296; thereby transferring a total of $5,000,000 out of his estate. However, if he forgoes making a gift this year and dies next year with all $5,000,000 still in his estate, then he will potentially pay 55% estate tax of $2,750,000, leaving only $2,250,000 to his heirs. See the illustration below: 

Gift tax                                                    Estate tax

$5,000,000                                              $5,000,000

$3,703,704 to heirs                                 $2,250,000 to heirs

$1,296,296 tax (25.9% of $5m)               $2,750,000 tax (55%)

By taking advantage of the low gift tax rate this year, our individual could transfer $1.35 of value for every dollar gifted, and paying tax only on $1.  Conversely, if he happens to make the gift in 2010 and also dies in 2010, than he has paid the $1.2m in tax, but would have owed no estate tax.  Fortunately, there are ways to deal with this uncertainty.  Here are a few thoughts:

Plan now – gift later – Making a taxable gift involves some advance planning.  Establish a plan now, and then make the gift late in the year, perhaps between December 26 and the 31^st.  Make sure gifts by check clear the bank before December 31; timing of a gift is very important to ensure it is a “complete gift.” 

Gift now – plan to reverse – If you plan now and wait to make the gift towards the end of the year, you still run the risk of missing out on the opportunity if Congress enacts a higher gift tax rate before the end of the year (seemingly more and more unlikely, but nevertheless, a possibility).  Consider making the gift now, but rather than directly to family members, making it to a trust with your family members as beneficiaries.  With the right trust provisions, the gift could be “reversed” through disclaimers.  In essence, this is sending the property back to the donor as if it were never gifted. 

If you are married, a lifetime marital trust or “QTIP” trust would also work if you want to make transfers to your children this year.  By setting up a QTIP trust for the benefit of our spouse during her life, which passes to your children at termination, your spouse could disclaim an amount in favor of your children. If the 35% gift tax rate changes or is repealed, then your spouse does not disclaim.        

Gift with little tax cost – There are several estate planning techniques commonly used to transfer highly appreciating assets with little or no gift tax.  Though some of these opportunities may be fleeting, they are currently still available. A grantor retained annuity trust (GRAT) would allow you to transfer significant value over a period of time with minimal or no gift tax cost. 

If you are planning to make a substantial charitable gift, but would still like to benefit family members as well, a charitable lead annuity trust (CLAT) will allow you to benefit a charity and your family with a single vehicle.  If you are considering converting to a Roth IRA this year, a CLAT could also offset some of your Roth conversion income (more on this below).    

Please contact us to help you with your gift or estate planning.

OFFSETTING ROTH CONVERSION INCOME

Converting a traditional IRA to a Roth IRA for many individuals works out great on paper, but writing the check to pay the income tax is where most lack enthusiasm to execute the switch.  Yet, you can’t beat the allure of the tax-free growth a Roth IRA has to offer.  Most importantly, if estate taxes ARE a factor for you, converting to a Roth IRA is virtually always a good idea.  There are ways to ease the tax bite.

Charitable gifts – Making a charitable gift of non-IRA assets to offset all or a portion of the conversion income could save tax dollars in favor of charitable dollars.  Perhaps you have a charitable deduction carry-forward that will soon expire, or you plan to make a large gift in 2011 that you could double up in 2010.  With some advanced planning needed, you could set up a charitable lead annuity trust (CLAT), which could benefit your charity, your family and reduce your conversion income.  Gifts of appreciated securities held for more than a year carry the additional benefit of avoiding capital gains taxes if they were to be sold.

You don’t have to convert everything – You may feel an “all or nothing” pressure to convert your entire IRA, but you don’t have to. This conversion opportunity is a permanent change that extends beyond 2010.  Converting only a portion of your IRA or spreading it out may make the tax bill more affordable.

Convert one into many – More than one Roth conversion can be made in a single year.  For example, as long as the money used does not come from a recharacterization, you could convert $500,000 in one transaction or you could do five separate $100,000 conversions. Separating the IRAs by asset class, can also be beneficial if any particular class does not perform as expected, you can recharacterize a subset of the conversion, rather than the entire amount.

Consider your losses – If you are anticipating a business loss in 2010 (as long as it’s not passive) or if you have net operating loss (NOL) carry-forwards, these can reduce your conversion income.  If you separate your conversion into multiple IRA accounts, you can recharacterize only the portion not covered by your NOL (once known for sure on your tax return).  A portion of one Roth IRA account can be recharacterized, but it has to be prorata by asset class.

Extensions – Extend the filing of your 2010 individual income tax return to October 15th.  This will allow you the most amount of time to determine the amounts of your NOLs or whether you should recharacterize due to a decline in value of the converted Roth IRA.

FUND A CREDIT SHELTER TRUST WITH A ROTH IRA

Because of the income tax burden, estate tax liability and the required minimum distributions (RMDs), a traditional IRA is not typically an asset used to fund a credit shelter trust.  Conversely, a Roth IRA may be the best asset to fund such a trust.  Since the asset grows tax free, has not RMDs and no income tax liability, it has a greater opportunity to be stretched over multiple generations.

Please contact us to help you evaluate your Roth conversion needs.