Tax Planning Update

During the month of June, the Senate was considering several pieces of tax legislation, among them the “American Jobs and Closing Tax Loop Holes Act” (Jobs Act) and the “The Small Business Jobs Tax Relief Act of 2010” (Small Business Act) and the “Homebuyer Assistance and Improvement Act of 2010” (Homebuyer Act).

Included in the Jobs Act was an extension of several tax breaks that had expired at the end of 2009. The most notable among them were the deduction for state and local sales taxes and tax-free contributions from retirement accounts to charitable organizations for those taxpayers over 70.5 years of age. To pay for the extended tax cuts and spending increases included in the bill, the Act also includes a number of tax increases aimed at closing tax “loopholes”. One of the provisions focused on self-employed service professionals who are paid through S-corporations. The bill would impose requirements on setting salary to ensure that appropriate amounts of Social Security and Medicare taxes are paid. Another provision focused on raising tax revenue related to “carried interest” commonly employed in investment vehicles like hedge funds and private equity pools as a means of “compensating” the investment’s sponsors. Under current law, carried interest is taxed as capital gain. Under the Senate bill, effective in 2013, carried interest would be taxed 65% as ordinary income and only 35% as capital gain; for assets held for 7 years or more, arrangements would improves to 55% capital gain/45% ordinary income. As of June 28th, the bill had not received the necessary number of votes and the Senate has now moved on to Small Business Act.

Among the provisions included in the Small Business Act are provisions that would lessen tax on the sale of certain small business stock and increase the limits on the deduction of trade or business start-up expenditures. One of the measures most relevant to the planning opportunities for some clients relates to Grantor Retained Annuity Trusts (GRATs). If the bill is passed as currently drafted, GRATs would be required to have a minimum 10-year term, the value of the remainder interest would have to be greater than zero and the annuity amount could not decrease during the first 10 year of the GRAT term. This would severely limit the effectiveness of GRATs as they are currently used for planning today. The Senate did not finish work on this bill before the Independence Day recess so, at the moment at least, until they reconvene on July 12, GRATs remain a viable planning tool.

However, President Obama did sign the Homebuyer Act on July 2nd. Prior to the Act’s passage, eligible home buyers who had binding purchase contracts on or before April 20th could take advantage of the Home Buyer Tax Credit so long as the purchase of their home closed on or before June 30, 2010. The signing of this Act extended the closing deadline from June 30th to September 30, 2010.

2010 Midyear Tax Planning Review

Half-way through the year, 2010 is shaping up to be one of the most unpredictable years on record for making tax planning decisions. Seemingly exhausted from partisan debate over short-term economic recovery incentives and the epic battle for health care reform, Congress has had little energy to focus on long-term tax policy. As a result, familiar provisions have been allowed to expire (with many more due to expire at December 31), leaving observers to speculate over what our tax structure will look like in 2011. Despite these uncertainties, here are a few of the topics we’ll be considering with our clients.

Estate Tax - Before the year began, Democratic congressional leaders announced their resolve that the scheduled one-year repeal of the estate tax in 2010 would not be allowed to take effect. In January, they indicated that the tax would be re-instated retroactively to January 1. It’s now July and Congress has still taken no action. As of this writing, there is no estate tax for 2010 and we think it’s too late for retroactivity. Stay tuned for further developments since this is sure to be a bargaining chip in other legislative efforts later this year.

Gift Tax – In 2010, the maximum gift tax rate dropped to 35%. It was 45% in 2009, and is scheduled to return to 55% in 2011. With the generation-skipping transfer tax temporarily repealed (along with the estate tax) for 2010 and scheduled to come back in 2011 at 55%, this year’s tax environment coupled with recent market retrenchments, may present a unique opportunity to accelerate family wealth transfers. It may be the last good opportunity for short term GRAT’s.

Income Tax – The maximum tax bracket for individuals is scheduled to increase from 35% to 39.6% in 2011. In addition, the capital gains tax rate will return to 20% and the tax on qualified dividends will jump from 15% up to normal ordinary rates after 2010. Therefore, this could be one of those rare occasions where high income taxpayers find it preferable to reverse traditional wisdom and accelerate taxable income into the current year and defer deductions to future years. For example, our discussions with clients regarding Roth IRA conversions and the timing of tax liability often conclude that taking the full tax burden in 2010 is the optimal strategy. Similarly, converting C Corporation wealth into cash by paying dividends, now, could be wise to avoid a much higher dividend tax in coming years.

Mike Angell
Director - Wealth Management
and Ray Edwards
Director - Tax Services

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