Year End Tax Update

There is a lot of uncertainty this year over what’s happening with taxes.  There are still steps you can take, however, to minimize your 2010 tax liability.  Please remember that most tax-saving provisions require planning and execution before year-end. We are ready to help you plan efficiently and effectively.

Federal Residential Energy Property Credit

Energy Efficient Improvements Tax Credit – You can receive a tax credit of 30% of the purchase price of qualified energy-efficient products, up to a maximum tax credit of $1,500. The $1,500 maximum applies to the total amount of credits claimed for the years 2009 and 2010 combined. That means your tax credits for energy-efficient improvements cannot exceed a total of $1,500 over both 2009 and 2010.

The following improvements are eligible for the tax credit:

  • Insulation materials and systems designed to reduce a home’s heat loss or gain;
  • Exterior doors and windows (including skylights) ;
  • Pigmented metal roofs designed to reduce heat gain, and asphalt roofs with appropriate cooling granules;
  • Electric heat pump water heaters;
  • Electric heat pumps;
  • Central air conditioners;
  • Natural gas, propane or oil water heaters;
  • Natural gas, propane or oil furnace or hot water boilers;
  • Advanced main air circulating fans; and
  • Biomass stoves that use “plant-derived fuel available on a renewable or recurring basis, including agricultural crops and trees, wood and wood waste and residues (including wood pellets), plants (including aquatic plants), grasses, residues, and fibers”.

Individual Tax Changes

The tax provisions enacted in 2001 and 2003–commonly referred to collectively as the “Bush tax cuts”–expire at the end of the year. While it’s probable that new legislation will extend some or all of these expiring tax provisions, election-year politics make it difficult to predict what action, if any, Congress will take. President Obama has said that he wants the cuts extended only for those taxpayers with less than $250,000 in income. With that in mind, here’s what you need to know about the major changes that are scheduled for 2011.

Federal income tax brackets Currently, there are six income tax brackets: 10%, 15%, 25%, 28%, 33%, and 35%. As it stands now, there will be no 10% bracket for 2011, and the remaining bracket rates will return to their original 2001 levels: 15%, 28%, 31%, 36%, and 39.6%.

For 2010, there is no phase-out of personal exemptions and the 3% limitation on itemized deductions does not apply.

Therefore, accelerating income into 2010 and deferring tax-deductible expenses to at least 2011 could lead to tax savings.  Careful consideration should be made, however, when deferring charitable donations, estimated state tax payments and other discretionary deductions to 2011 given that the limitation on itemized deductions for individuals is expected to return.  The Alternative Minimum Tax (“AMT”) should also be taken into account.

If you have a net operating loss (NOL), instead of carrying the loss back to previous years, it may be more beneficial to carry the loss forward in order to offset income in higher tax years.

Capital Gains/Qualified Dividend Tax RatesFor 2010, if you sell shares of stock that you’ve held for more than a year, any gain is a long-term capital gain, generally taxed at a maximum rate of 15%. If you’re in the 10% or 15% marginal income tax bracket, however, you’ll pay no federal tax on the long-term gain (a 0% tax rate applies). That means if you’re a married couple filing a joint federal income tax return, and your taxable income is $68,000 or less, you pay no federal tax on the gain.

However, these rates are due to expire at the end of 2010. Beginning in 2011, an expected 20% rate will generally apply to long-term capital gains. Individuals in the 15% tax bracket (remember, there won’t be a 10% bracket in 2011) will pay the tax at a rate of 10%. Special rules (and slightly lower rates) will apply for qualifying property held for five years or more. Finally, while qualifying dividends are taxed in 2010 using the same capital gains tax rates described above (i.e., 15% and 0%), in 2011 they’ll be taxed as ordinary income subject to the increased 2011 tax brackets.

Since the long-term capital gains tax rate is expected to increase, it may be beneficial to sell appreciated long-term securities or other assets in 2010.  You may also benefit from postponing tax loss harvesting until 2011 since the losses could be used to offset long-term capital gains at a tax rate of potentially 20 percent versus only 15 percent in 2010.

Consider a Roth IRA ConversionStarting in 2010, taxpayers of all income levels have been given the option to convert a traditional IRA to a Roth IRA. Roth IRAs provide several advantages over traditional IRAs, the biggest ones being the potential for tax-free income in retirement (especially since tax rates are expected to rise) and the fact that Roth IRAs do not require minimum distributions at age 70 ½.

By default, upon conversion 50 percent of the IRA’s value is reported on your 2011 tax return and the remaining 50 percent on your 2012 return. However, you can elect to pick up 100 percent of the value on your 2010 return, which allows you to pay taxes at the lower ordinary income tax rate.

Tax Changes for Small Businesses

Bonus Depreciation – The Small Business Jobs Act expands bonus depreciation for one year. This tax deduction enables a business to expense fifty percent of the cost of new equipment, such as computers or software, in the year of purchase. The remaining cost is depreciated over the normal life of the equipment.

Section 179 Deduction – The section 179 deduction will have a maximum deduction amount of $500,000 for the years 2010 and 2011 under the Small Business Jobs Act.

Cell Phones – Business owners will no longer have to keep track of individual calls on their cell phone plans. The Small Business Jobs Act removes the listed property classification from cell phones and mobile telephone service.

Start-up Expenses – Entrepreneurs have long depended on the start-up expense deduction, whereby the first $5,000 of expenses incurred before a business actually begins can be deducted in full once the business opens its doors for business. The Small Business Act expands this deduction to $10,000 for the year 2010 only.

Health Insurance Deduction – Self-employed people can now deduct the cost of their own health insurance as a business expense that will reduce their self-employment tax. This tax reducing provision is valid only for the year 2010. For 2009 and presumably for 2011, the deduction for health insurance is an above-the-line adjustment that reduces the regular income tax but does not reduce the self-employment tax.

Increased 1099 Reporting – Beginning in 2012, taxpayers with business income must issue 1099 forms to all vendors from whom they purchase more than $600 worth of goods and services that year.

Estate, Gift And Generation Skipping Transfer Tax

There is currently no estate tax for 2010, and special rules are in place that govern the way basis is calculated for property passing upon death. The estate tax is scheduled to reappear in 2011, however, with a $1 million exclusion amount (meaning that up to $1 million of assets will be exempt from estate tax) and a top tax rate of 55%. To put that in context, for 2009, the top estate tax rate was 45%, and estates received an exclusion of $3.5 million.

Year 2009 2010 2011
Estate tax exclusion $3.5 million N/A $1 million
Top estate tax rate 45% No tax 55%

The annual gift tax exclusion for 2010 is $13,000 (couples can give $26,000).  If you are considering gifting assets over that amount, doing so in 2010 while the gift tax rate is at a historically low 35 percent and, in certain circumstances, asset values are depressed, could lead to significant transfer tax savings. Gifting essentially reduces the value of your taxable estate and allows the gifted assets to grow in the hands of your beneficiaries outside your taxable estate.

The window for establishing short-term grantor retained annuity trusts (“GRATs”) may be closing as Congress has introduced several bills incorporating proposals to limit this valuable planning strategy. Under these proposals, the minimum term for establishing GRATs would be ten years, which decreases the flexibility of this favored transfer strategy. This probable Congressional limitation, coupled with today’s historically low interest rates, makes this the time to take action for those individuals interested in transferring significant wealth to their families.

The generation skipping transfer (“GST”) tax which is levied on asset transfers to generations two or more levels younger than the taxpayer (i.e., grandchildren) is currently dormant. In other words, the GST tax rate is 0 percent for 2010. Therefore, if you are considering gifting assets to your grandchildren, now may be the time. Care should be taken to avoid making such gifts to trusts or UGMA/UTMA accounts, however, since there are concerns that distributions from those accounts may become subject to GST tax in the future.

An important item to note when making gifts this year is the possibility that Congress could reinstate the higher gift tax rate and/or the GST tax retroactively to January 1, 2010 which would create tax liabilities for transfers or bequests that have already taken place.

Other Important Changes

Other changes for 2011 include:

Phase-out of itemized deductions and exemption amounts–Itemized deductions and personal exemption amounts will once again be phased out for higher-income individuals.

The “marriage penalty” returns--Changes made to correct the federal income tax “marriage penalty” expire at the end of 2010, resulting in a reduced standard deduction amount and lower tax bracket thresholds (i.e., higher rates will apply at lower income levels) for married couples filing jointly in 2011.

Tax credits get cut–The child tax credit will be reduced and both the Hope education tax credit and the earned income tax credit become less generous (the Making Work Pay tax credit also disappears).

Other Items of Note

Charitable Contributions – In order to deduct gifts to charity, you must have a receipt showing the organization’s name, the date of the donation, and the amount of the contribution.

IRS “Phishing” Scams – The IRS is warning consumers that another phishing scam is actively soliciting victims. If you receive e-mail from the IRS asking for information, delete it. The IRS does not send out unsolicited e-mails asking for personal information.

Flexible Spending Account (FSA) Changes – Beginning in 2011, FSA funds cannot be used for over-the-counter medicines unless specifically prescribed by a doctor. Currently, FSA funds can be used for OTC drugs and other items such as eyeglasses, contact solution, bandages and non-prescription forms of birth control.

E-Filing – Beginning with the 2010 filing season, we will be required to e-file most tax returns.  This is going to be a benefit to our clients.  All records can now be stored and sent to you on CD, and your return can be signed from anywhere.  We will provide you with more details soon!

What’s Coming

Health Care Reform – The Health Care reform bill contains new tax provisions which will take effect in 2013.  Singles earning more than $200,000 and couples making more than $250,000 (in modified adjusted gross income) will pay an extra 0.9 percent of their wage income. In addition there is an entirely new tax of 3.8 percent on investment income.

Stock Basis Reporting – The IRS is requiring reporting of basis and other information by stockbrokers and mutual fund companies for most stock purchased in 2011 and all stock purchased in 2012 and later.  Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, will be expanded in 2011 to include the cost or other basis of stock and mutual fund shares sold or exchanged during the year, and stockbrokers and mutual fund companies will use Form 1099-B to report this information at year-end. They will also use the expanded form to report whether gain or loss realized on these transactions qualifies as long-term or short-term gain or loss.

H&A obtains Release of Wrongful Levy by IRS

In this case, taxpayers had a 1.5 million dollar lien against them individually for past due personal income taxes and penalties.  Taxpayers owned a limited liability company which ran an operating business. The IRS attempted to place a levy on the limited liability company’s bank account to satisfy the lien.  The levy would have catastrophic consequences for the operating business and the livelihoods of those who work for or do business with the company, including taxpayers.  H&A prepared a request for removal of the wrongful levy, which was eventually accepted by the IRS.    Thanks to the efforts of our team, the limited liability company was able to continue operations, and those affiliated with the company were largely unaffected. 

We cannot guaranty success in a wrongful levy claim.  The success or failure of a wrongful levy claim will depend on the facts and circumstances of each separate case.  If you need help dealing with the IRS, please do not hesitate to contact us at (404) 255-7400.

H&A Wins Self Dealing Penalty Abatement

The IRS confronted our client with an assessment of over $700,000 in self dealing transaction penalties under Internal Revenue Code Section 4941 for its dealings with a private foundation.  H&A obtained a full abatement of the assessed penalties through hard work,  creative thinking, and attention to detail.  This was a collaborative effort by our tax controversy team and is a testament to the wide ranging skills and knowledge offered to our clients.

We cannot guaranty abatement of penalties.   The success or failure of a request or claim for penalty abatement depends on the facts and circumstances of each individual case.  If you need help dealing with the IRS, please call or email Hoffman & Associates today at 404.255.7400.

Governor signs Senate Bill 461

Governor Perdue signed Senate Bill 461 on May 28, 2010, making the provisions thereof retroactive to January 1, 2010.  As discussed, the law allows married Georgia residents to utilize the entire step up in basis provided under the current estate tax laws without modification to current documents.

If you have any questions about this law or how it affects your estate plan, please give us a call.

Georgia Senate Bill 461 and Funding of the Marital Trusts

As a previous article stated, the Federal Estate Tax purported repeal and the new carryover basis rules could cause problems for older Wills of married persons where the Will is drafted to maximize the Federal Estate Tax Exclusion.  The Georgia legislature is in the process of passing a bill that would all the language of the older Wills to fully fund the marital trusts for the benefit of spouse until Congress settles whether or not there will be a federal estate tax.  This bill allows married Georgia residents to utilize the entire step up in basis provided under the current estate tax laws and will become effective when Governor Perdue signs it.  To view a text of Senate Bill 461, click here.

To recap the issue, as most Wills are currently drafted, a formula is used to maximize the federal estate tax allowance that is in existence at the time of a person’s death.  If a married individual dies in 2010, his entire estate would pour over to the Credit Shelter Trust under his will, leaving no assets to fund the Marital Trust which is necessary to maximize the spousal step up in basis).

If you are unsure of how your Will works or have questions about the funding of trusts under your Will, please give us a call.

Federal Estate Tax Laws that may affect your Will

As a result of the 2001 tax legislation, the Federal Estate Tax has purportedly been repealed for 2010.  While Congress is still debating the issue, as it stands now if a person were to die in 2010 there might be no federal estate tax on their estate.  Additionally, step up in basis of assets to the date of death value is virtually eliminated.  There is an exception to the step up in basis in that a spouse can elect to step up the basis in $3,000,000 worth of assets and other individuals can elect to have $1,300,000 of assets stepped up in basis.  All other assets will be inherited with a carryover basis from the time the decedent acquired the property.

As a result of this new carryover basis rule, there could be an issue with capturing the basis increase in $3,000,000 of assets passing to spouse under a Will.  In order to qualify for the step up in basis on the $3,000,000, the property must be held in what is known as a qualified terminable interest property trust.  As most Wills are currently drafted, a formula is used to maximize the federal estate tax allowance that is in existence at the time of a persons death.  While no one anticipated that Congress would actually allow a total repeal of the federal estate tax law, we are currently faced with that issue.  There is talk that if Congress reinstates the federal estate tax they will make it retroactive back to January 1, 2010.  However, some may challenge this as unconstitutional and we do not know if they would be successful.

Therefore, we want to inform everyone that under the current law, if a formula is used in your Will to maximize the funding of the Credit Shelter Trust, all of your assets will go to that under your Will.  What this means is that your surviving spouse may lose the right to get a step up in basis on $3,000,000 worth of assets as no assets from your estate will go to the QTIP Marital Trust.  Some argue that your family could go to court and argue that your intent was not to have all assets pass to the Credit Shelter Trust and that the court may “revise” the Will to accomplish your intent to fully maximize all benefits affordable to your spouse.  Unfortunately, we cannot advise whether this argument would be successful.

Of course, if the federal estate tax is reinstated and made retroactive, there is no issue.  However, if it is not retroactive, and if you pass away during a “total repeal” period (2010), your spouse and family may lose out on the benefits of a step up in tax basis.

Therefore, it is advisable that you contact an attorney to execute a Codicil to your Will to assure assets that pass to your spouse will be allowed to fully utilize the step up in basis rule.

Federal Estate Tax Laws that may affect your Will in a Second Marriage

As a result of the 2001 tax legislation, the Federal Estate Tax has been repealed for 2010.  While Congress is still debating the issue, as it stands now if a person were to die in 2010 there might be no federal estate tax on their estate.

There could be an issue with providing assets for some spouses under a Will, particularly if it is a second marriage.  Typically, a Will is drafted utilizing a formula to maximize the federal estate tax allowance that is in existence at the time of your death.  While no one in the legal and accounting communities anticipated that Congress would actually allow 2010 to arrive with a total repeal of the federal estate tax law, we are currently faced with that issue.  There is talk that if Congress reinstates the federal estate tax they will make it retroactive back to January 1, 2010.  However, some may challenge this as unconstitutional, and we do not know if they would be successful.

Therefore, under the current law, if the typical formula is used in your Will to maximize federal estate tax allowances, all of your assets will go to the Family Trust, also known as the Credit Shelter Trust.  What this means is that if your spouse is not named as a beneficiary under the Family Trust, they will not get any benefit from your estate as the Marital Trust created for the benefit of the spouse will not receive any assets from your estate.

In some instances in second marriages, a person’s Will provides for spouse under a Marital Trust and for children from a previous marriage under the Family Trust.  Therefore, under the current tax law this is detrimental to the surviving spouse, as all assets will go to the children from the previous marriage.  If this is not your intent, it is advisable that you contact an attorney to execute a short Codicil to your Will to assure assets will pass to a spouse in a second marriage.

Of course, if the federal estate tax is reinstated and made retroactive, there is no issue.  However, if it is not retroactive, if you pass away during a “total repeal” period (2010), your spouse will lose out on the benefits of your estate.

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