Planning for Income and Estate Taxes in an Uncertain Time

While 2010 was a year of the zero estate tax (since Congress failed to act at the end of ’09), if Congress fails to act yet again, 2011 will be a year of the lowest exemption and highest rate we’ve seen in 10 years (55% tax rate on estate valued above $1 million).  At levels like these, far more than the wealthiest 1% of Americans will be impacted. That’s because at this level, regular people with homes, life insurance, bank accounts, etc. will likely be impacted since the government does not discriminate between hard and soft assets – these are lumped together when taxing an estate. This is particularly concerning to family businesses which would be taxed on the value of their stores and be expected to payout the government in cash. David P. Kron, a partner with Florida law firm Ruden McClosky, speaks to the New York Times about what families and individuals can do to prepare their estates in these uncertain times.

 

Last year, every tax adviser was confident that Congress would devise some fix to the estate tax before the year was over. When that did not happen, advisers predicted that a fix would come early this year. Then they said it would happen this summer. But the fix never came, and the estate tax lapsed this year. Now, in the midst of a flurry of tax proposals, not to mention the Republican gains in the midterm elections, legislators have only five weeks to act on the estate tax before the holiday recess. And taxes — both the estate tax and the income tax — are far from the only issues on Congress’s agenda.

Few tax planners and lawyers are willing to speculate on what will happen in the last months of 2010. They learned their lesson last year. But Alfred Peguero, a personal finance partner at PricewaterhouseCoopers, said his firm believed the weeks of Dec. 6 and 13 offered the best window for a decision on the estate tax. If Congress does not act, the estate tax will revert to its 2001 level — a 55 percent tax rate for individual estates larger than $1 million. This will force seven times the number of estates to file estate tax returns next year as in 2009, when the individual exemption was $3.5 million and the rate was 45 percent, according to a report from the Tax Policy Center, a Washington research group. The group said 108,000 estates would have to file returns under the lower exemption and 44,000 would pay tax, compared with 15,000 estate tax returns in 2009 with 5,500 owing tax.

There are few concrete solutions to planning for something as uncertain as the time of death and Congressional action on taxes. But several accountants, lawyers and financial advisers offered a few suggestions on things to do before year-end. All carry risks.

A year with no estate tax has led to a lot of macabre jokes about ending the life of an elderly relative. And much was made of two billionaires — George Steinbrenner and Dan Duncan — who died this year and whose estates will presumably go untaxed. But the absence of an estate tax for just one year and the lack of guidance from the Internal Revenue Service on how to handle other death-related taxes that could be owed this year has created another problem. Assets do not get valued at the date of a person’s death, as they would with an estate tax. Instead, heirs have to calculate the assets’ appreciated value and pay capital gains tax on that amount.   There are provisions in the tax code to give people a limited amount of relief from taxes on capital gains. But the process is onerous and so far the I.R.S. has released only a draft version of Form 8939, which will be needed to file those taxes in April.

Leiha Macauley, a partner in the individual clients group at Day Pitney, a law firm in Boston, has an even more complicated problem. In May, a client died with an estate worth some $20 million, which he had left to his wife through a simple will. His widow, however, is 93. Lawyers have drawn up the paperwork that would allow her to disclaim her husband’s property. It would then pass estate tax-free to her children. But they are waiting to file the paperwork to make sure she lives to the end of the year. They want to make sure there is no retroactive estate tax, which her children would then have to pay. Also, her husband left gifts of $500,000 to each of their grandchildren, all minors. There is no generation-skipping transfer tax this year, though there had been one until last year. But putting the gifts in a trust, as would normally have happened, could subject them to taxes if the grandchildren eventually withdrew the money and such a tax had been reinstated. The only upside is how the widow is handling the predicament.

“She has a great sense of humor,” Ms. Macauley said. “She said she only wants to have enough to live on, furnish her one-bedroom apartment and pay for her driver.”

Whatever happens to her, there are far more people of modest means who may have to confront the planning process in 2011 or risk paying an unexpected estate tax. And affluent people may be shocked by the costs to minimize the portion of their estate over $1 million for an individual or $2 million for a couple.

Even at the low end, the costs could be around $4,000 to $6,000, said Stuart Horowitz, senior partner at Andrew Stuart Asset Management Group in Coral Springs, Fla. His firm’s core clients are retired couples with around $2 million, meaning they could be subject to an estate tax they did not have any reason to plan for. The more frustrating issue could be the uncertainty if nothing happens this year. Because of the costs and the time involved, no one wants to have to redo everything if in six months the law changes.

Of course, the estate tax is not the only tax in flux. The income tax could also go up. Or it could go up just for wealthier people. Or it could stay the same, for a few years at least. Planning for something in an environment this uncertain is dicey. But there is one idea being floated as a hedge. If income tax rates in the top bracket go up to 39.6 percent next year, taxpayers could get a higher charitable deduction by waiting to make their gifts in January, particularly those now subject to the 28 percent alternative minimum tax who find themselves subject to the higher rate. (The A.M.T. is a parallel tax system for certain high earners.)

Susan R. Colpitts, executive vice president of Signature, a wealth management firm, has been suggesting that some clients delay big gifts because the potentially higher rate next year would mean a higher charitable deduction. A higher rate would mean donations would only cost 60 cents on the dollar. (Most charities operate on a fiscal, not a calendar, year, so they would be unaffected by the timing.)

The big risk is if Congress ends up extending the current tax levels and this year’s income tax bill goes up because you postponed a charitable deduction. “You may or may not get paid back for it, but you need to consider it,” Ms. Colpitts said.

he corollary of delaying a charitable deduction is selling securities that have appreciated substantially. One tax that is set to rise is on capital gains, to 20 percent from 15 percent. Investors with large capital gains in securities or private companies could benefit from selling them and paying the lower tax now. The downside of this is that on $1 million of gains in a stock, you would have to pay $150,000 in taxes today and then hope to make it up. But that is just another level of uncertainty when years of diligent planning are now subject to the vicissitudes of Congressional wrangling.