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Heather A. Kmetz
503.243.1661 x 226

Favorable Law for the Wealthy and the Not So Wealthy

February 2011

Heather A. Kmetz
503.243.1661 x 226

Published in The Daily Journal of Commerce

The definition of "wealthy" is a moving target – especially over the last decade.

Under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ("2010 Act"), enacted on December 17, 2010, both "wealthy" and the "not so wealthy" may realize improved economic positions in the next two years.

The package extends unemployment benefits, reduces the Social Security payroll tax for individuals, and raises the threshold for the alternative minimum tax ("AMT") through 2011.  Further, it extends the Bush-era tax cuts, increases transfer tax exemption amounts, and reduces transfer tax rates through 2012.  There are also new incentives to invest in machinery and equipment, and it retroactively resuscitates and extends numerous tax breaks for individuals and businesses.

The 2010 Act replaces what was considered, by most measures, a relatively unpalatable set of laws that was scheduled to come into effect starting January 1, 2011, and employs a shot-gun approach – something for everyone – in hopes that the combination of law changes will provide meaningful net value to the national economy by the end of 2012.

Here are some details concerning key elements of the 2010 Act:

Unemployment Benefits, Employment Tax Breaks, and Working Family Tax Credits.  Federal unemployment benefits were extended 13 months, benefiting an estimated 7 million workers whose benefits were scheduled to expire.  Employees and self-employed workers were given a 2 percent reduction of the Social Security tax, bringing the rate down from 6.2 percent to 4.2 percent for employees, and from 12.4 percent to 10.4 percent for the self-employed through 2011.  Key tax credits for working families were extended through 2012, including the $1,000 child tax credit (and maintains its expanded refundability) and the American Opportunity tax credit for higher education (and its partial refundability).

Extension of "Bush-era" Tax Cuts, AMT "Patch," and Charitable Roll-overs.  Favorable individual income, capital gains, and dividend tax rates that were in effect in 2010 are now extended through 2012, thus retaining the 10 percent income tax bracket at the bottom and the 35 percent income tax bracket at the top.  This two-year extension of favorable income tax rates provides planning opportunities for individuals who may consider accelerating future income into these two tax years or converting an IRA to a Roth IRA.

For 2010 and 2011, there was a modest increase in the AMT exemption amounts and a number of personal nonrefundable credits are permitted offsets to AMT (as well as regular tax).  Also, higher-income will no longer face previously-scheduled reductions in itemized deductions and a phaseout of personal exemptions in 2011 and 2012.

The IRA charitable rollover has been extended through 2012, allowing individuals who are age 70½ and older to distribute up to $100,000 from the IRA directly to a public charity without reporting the distribution as income.

Business Benefits.  Businesses can write off 100 percent of their new equipment and machinery purchases in the placed-in-service year, 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 percent additional first-year depreciation.  The 2010 Act also includes beneficial provisions aimed at energy-related businesses, including the extension of a program that provides cash payments in lieu of renewable energy tax credits, designed to support jobs in the wind and solar industries.

Unified Gift and Estate Tax.  Under the 2010 Act, the federal estate tax exemption was raised to $5 million, the maximum estate tax rate is limited to 35 percent, and beneficiaries receive a "stepped-up" basis in a decedent's assets.  But that is only helpful if you have the bad fortune of dying in 2011 or 2012.  More meaningful from a wealth transfer planning perspective was the reunification of the federal gift and estate tax credit.  Since 2002, the lifetime gift tax exclusion amount was limited to $1 million; it is now $5 million.

Understandably, individuals did not want to pay tax on lifetime transfers that would transfer free of tax if held until death.  However, this retention of wealth increases their potential federal estate tax liability due to the included appreciation and perhaps delays a younger generation's opportunity to put that wealth into more productive use through innovation and investment.  Under the 2010 Act, individuals now can gift up to $5 million – $10 million for married couples – free of gift tax, and lifetime gift transfers totaling more than this amount in 2011 and 2012 will be subject to a federal gift tax of no more than 35 percent.

Although many are still trying to gain back losses of the Great Recession and still others are simply unwilling to make substantial gifts for fear that they will not have sufficient wealth retained for themselves, what to do with this "additional" $4 million gift amount is an interesting discussion for those able and willing to entertain it.  Persistently low interest rates and low valuations of closely-held businesses demand that relatively well-heeled business owners consider wealth transfer tax strategies that may have a short window of opportunity.

Unused Credit Available to Surviving Spouse ("Portability").  The 2010 Act introduces "portability" of the newly reunified gift and estate tax exemption amount into the law.  Any unused amount attributable to a 2011 or 2012 decedent now can be used by the surviving spouse.  If a decedent left all assets to a surviving spouse and did not have any planning to preserve the exemption amount or died with an estate of less than $5 million, the surviving spouse could transfer during lifetime or at death the decedent's unused amount (up to $5 million) plus the surviving spouse's remaining amount (as calculated under applicable law in the year of transfer – up to $5 million in tax years 2011 and 2012).

Additionally, the portability provision may enhance certain creditor protection planning through this two-year period, as spouses who have intentionally maintained separate assets need not be concerned that the estate tax exemption amount of a "poorer" spouse would be lost if such spouse predeceased the "wealthier" spouse.

The portability provision is not automatic; an election must be made on a timely-filed federal estate tax return for the deceased spouse, even if the deceased spouse's estate value does not otherwise necessitate filing of a federal estate tax return.

Comprehensive Future Tax Reform?  The 2010 Act is a set of temporary tax policies negotiated between Congressional Republicans and the White House, designed to stimulate a tentative economic recovery, encourage business growth and sustained employment, and satisfy campaign promises.  It also defers discussion of any comprehensive tax reform until 2012 – promising an interesting presidential election year.

Heather A. Kmetz is a Partner with the law firm of Sussman Shank LLP and Chair of the Firm's Tax Group.  Heather assists individuals and businesses in establishing tax-sensitive wealth preservation plans and transactions and serves as outside corporate counsel for a variety of closely-held businesses.  You can reach Heather at (503) 227-1111 or hkmetz@sussmanshank.com

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