Tuesday, May 29, 2012
GREAT ARTICLE: Preparing for 'Taxmageddon' by BILL BISCHOFF
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he 2010 Bush tax cut extension legislation also established a favorable, but temporary,
federal estate and gift tax regime for 2011 and 2012. But we will go back to the bad old days on Jan. 1, 2013, unless Congress
takes action and the president goes along.
Some commentators are calling the end of the income tax cuts, in conjunction with the scheduled demise of the current beneficial estate and gift tax provisions, as "taxmageddon."
Here's what you need to know, starting with where we stand right now.
Snapshot of the Current Rules
$5.12 Million Exemption and Flat 35% Tax Rate
For estates of individuals who die in 2012,
the federal estate tax exemption is $5.12 million, and so is the lifetime federal gift tax exemption (up from $5 million for
2011). The estate tax rate on the taxable value of an estate in excess of the exemption is a flat 35%, as is the gift tax
rate on lifetime gifts in excess of the exemption (same rate as for 2011).
Deceased Spouse's Unused Exemption
The unused unified federal estate and gift tax exemption of an individual who dies in 2011 or
2012 is "portable," which means it can be passed along to the surviving spouse. The portable exemption provision,
in conjunction with the longstanding unlimited marital deduction provision, means the first spouse to die can leave everything
to the surviving spouse without any federal estate tax hit (assuming the surviving spouse is a U.S. citizen and is therefore
eligible for the unlimited marital deduction). If the first spouse dies in 2012, the surviving spouse will then have two $5.12
million exemptions to work with, for a total of $10.24 million -- assuming the surviving spouse also dies in 2012.
Point: Before the portable exemption deal, it was often necessary to take tax planning steps like: (1) transferring assets
between the spouses while they were both still alive in order to equalize their respective estates or to make sure each spouse's
estate was worth at least the estate tax exemption amount; and (2) setting up credit shelter trusts to make sure the estate
tax exemptions of both spouses were taken advantage of without shortchanging the surviving spouse. Such steps are a pain and
they might become necessary again in 2013 and beyond, depending on what happens with the estate and gift rules.
Basis Step-Up for Inherited Assets
For heirs of individuals who die after 2010, the familiar rule that allows
the federal income tax basis of inherited capital-gain assets (such as real estate and stock) to be stepped up to reflect
the date-of-death fair market value has been reinstated. That means heirs won't owe any federal capital gains taxes on asset
appreciation that occurs through the date of death -- as long as that date is after 2010. The good news: this taxpayer-friendly
rule is not scheduled to disappear at the end of 2012 (it's permanent, unless Congress changes its mind which has been known
Taxmageddon Scheduled for 2013
The current estate and gift tax rules are as taxpayer-friendly
as anyone could have reasonably hoped for, but most of the good stuff is only locked in for 2011 and 2012. Expect estate and
gift taxes to become major bones of contention during the lead-up to the Nov. 6 general election. What happens in 2013 and
after will probably depend on how the election turns out.
If nothing gets done on the estate and gift tax front, we
will automatically go back to the unfriendly regime that was in effect before the Bush tax cuts were enacted. That would mean
a paltry $1 million unified estate and gift tax exemption (versus $5.12 million under the current rules) and a whopping maximum
estate and gift tax rate of 55% (versus 35% under the current rules). In addition, the portable exemption privilege would
At this point, it's unclear what will happen, but I can foresee at least four possibilities.
Old Rules Return as Scheduled: This is a possibility if the Democrats retain the Senate and the Presidency and retake
Existing Favorable Rules Are Extended: This is a good possibility if the Republicans seize
the Senate and the Presidency.
Estate and Gift Taxes Are Completely Repealed: This is a possibility
if the Republicans win the Senate and the Presidency, but it is less likely than an extension of the current rules.
Good 2009 Rules Return: In 2009, we had a $3.5 million estate tax exemption, a $1 million gift tax exemption, and
a 45% maximum estate and gift tax rate. If the November election results in a mixed outcome, returning to the 2009 rules might
be a compromise that both Democrats and Republicans could swallow.
Dealing with Uncertainty
Sadly, we will probably
not know the estate and gift tax situation for 2013 until several weeks into the lame duck Congressional session that will
convene after Nov. 6. If you have a good-sized estate, be prepared for an emergency year-end meeting with your professional
adviser to react to whatever happens -- or doesn't happen.
Friday, May 25, 2012
WEEKLY QUESTION: May the Grantor of Section 2503(c) Minor's Trust serve as a Trust Investment Manager?
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ANSWER: Probably Shouldn't. Because
the Advisers' authority is so broad, if the grantor is an Adviser, the powers may cause the trust to be included in the grantor's
estate as a retained power to control beneficial enjoyment. (IRC §§2036, 2038(a)(2))
Wednesday, May 16, 2012
What is Stepped Up Basis? Often Mentioned, Rarely Understood!Stepped Up BasisBasis refers to the amount
generally used for tax purposes to calculate gain or loss on a sale of an asset. In simple terms it is the price paid for
the asset, plus the cost of post acquisition improvements, less depreciation allowed or allowable (if you didn't claim depreciation
you were entitled to, it is still applied to reduce basis).
Stepped Up Basis is an increase in the basis of an
asset, such as at death of the owner, usually to the fair market value of the asset.
Example: You purchased raw
land for $100,000. Five years later you build a fence around the land and pave a drive, all for a cost of $20,000. Your tax
basis is $120,000. No depreciation was allowed or allowable. On your death the land was worth $300,000. The basis of the land
is stepped up to $300,000. If instead you gave the land to your children before death their tax basis would be $120,000, called
"carry over basis". Even though the land had appreciated to $300,000 by your death, because you had given it away
before death. This basis "step up" will eliminate any capital gains inherent in the asset.
up becomes more complex if the asset is owned by an entity. If the land was owned by a corporation you in turn owned, you
would get a basis step up in the stock of the corporation, but there would be no basis step up for the underlying land. If
you owned 50% of a partnership or limited liability company that owned the land, the partnership or the limited liability
company (taxed as a partnership) would have to make a special election under the partnership tax law provisions (Section 754)
to adjust the basis in the land.
In the year 2010 the estate tax is scheduled to be repealed and with it will disappear
(really, be modified) the above basis adjustment. This is an increase in the adjusted tax basis (cost to purchase, less depreciation
if applicable, plus improvements if applicable) of an asset to the fair market value of the asset at death. In 2010, if the
executor chooses for the estate to be subject to the estate tax, the assets in the estate will all be stepped up (assuming
they are appreciated) in this manner without limit. If in 2010 the estate is subject to the carryover basis rules the step
up in tax basis may be limited to $1.3 million for bequests to anyone other than a spouse and an additional $3 million step
up on bequests to a spouse (or trust qualifying for similar treatment).
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