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Estate Tax Update In The Year of "Repeal"

Estate Tax Update In The Year of "Repeal"

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  • 1. 2009 TAX RETURN PREPARATION ISSUES AND ESTATE TAX UPDATE A Presentation By: J. Scot Kirkpatrick, Esq. And Karen S. Kurtz, Esq. February 17, 2010
  • 2. Tax Legislation – Home Ownership Certain taxpayers who purchased or will purchase new homes are eligible for a homebuyer credit. § “First-Time Homebuyer Credit” – A tax credit of up to $8,000 is available for eligible taxpayers who purchase or enter into a binding contract on a home during 2009 or before May 1, 2010. § To be eligible – § Prior to November 6, 2009 – MAGI of $75,000 ($95,000 cap)/$150,000 ($170,000 cap) § After November 5, 2009 – MAGI of $125,000 ($145,000 cap)/$225,000 ($245,000 cap) § Existing Home Owners – A tax credit of up to $6,500 is available to existing home owners who have lived in the same principal residence for any five consecutive year period during the past eight years. The same eligibility requirements for the first-time credit apply to existing home owners. -2-
  • 3. Tax Legislation – Home Ownership Certain taxpayers who purchased or will purchase new homes are eligible for a homebuyer credit. § Claim the credit using Form 5405. § Taxpayers claiming the credit must file a paper return and include a copy of the settlement statement. § Existing homeowners should also include a mortgage interest statement, property tax records, or homeowner’s insurance records. § The credit must be paid back if the house is sold within three years of the date of purchase or ceases to be the principal residence. § Members of the Armed Forces and certain federal employees serving outside the U.S. have an extra year to buy a principal residence in the U.S. and still qualify for the credit. -3-
  • 4. Tax Legislation – Home Ownership Income tax breaks for assistance with or cancellation of mortgage indebtedness. § Cancellation of Indebtedness Income Exclusion for discharge of “Qualified Principal Residence Indebtedness” occurring after December 31, 2006 and before January 1, 2013. § Pay-for-Performance Success Payments Not Taxable – Home Affordable Modification Program (“HAMP”). § Rev. Rul. 2009-19 deemed payments received under HAMP excluded from income under the general welfare exclusion. -4-
  • 5. Tax Legislation – Vehicles § Sales Tax Deduction for New Vehicles – Eligible taxpayers may deduct the sales tax paid on the cost of new automobiles, motor homes, light trucks and motorcycles purchased (not leased) after February 16, 2009 and before January 1, 2010. § Treat as an itemized deduction on Line 5 or Line 7 of Schedule A § Non-itemizers may add such tax to their standard deduction on the new Schedule L (limits and phase outs apply to non-itemizers). § “Cash for Clunkers” Not Taxable – A $3,500 or $4,500 voucher or payment received under the “Cash for Clunkers” program does not have to be reported as taxable income. -5-
  • 6. Tax Legislation – Miscellaneous § Credit for Residential Energy Efficiencies – Taxpayers may receive an unlimited credit for up to 30% of the cost of solar water heating equipment, solar electric systems, geothermal heat pumps or small wind turbines. A credit may also be available for energy-saving home improvements. § Bonus Depreciation and Section 179 Expenses – The additional 50% first year depreciation allowance for qualified property was extended by the American Recovery and Reinvestment Act of 2009. § New College Tuition Credit – American Opportunity Credit permits eligible taxpayers a $2,500 credit per student per year for four years of college. The credit phases out at $80,000AGI/$160,000AGI. § Payroll Tax Credit – “Making Work Pay Credit” of 6.2% of earned income up to $400 for single filers and $800 for joint filers. -6-
  • 7. Individual Returns – Retirement and Savings § Contribution Limit for 401(k) Plans – For 2009 the contribution limit increases to $16,500. Workers age 50 or older can put in an additional $5,500 for a total contribution of $22,000. The limits are scheduled to remain the same in 2010. § IRAs and Rollovers – § Expanded deductions may be available if AGI is less than $65,000. § Late IRA Rollovers were permitted before November 30, 2009. § No required minimum distributions for 2009. § Early distribution penalty waived for period payment modification for higher education. § 2009 is the last year for direct donations of IRAs to charity are permitted without reporting the transfer as income. 2009 is also the last year the special Enron IRA rule applies. § The U.S. Department of Labor deemed a requirement that a client pledge his personal account to cover indebtedness of his IRA a prohibited transaction. -7-
  • 8. Individual Returns – Children and Parents § Kiddie Tax – In 2009, a child’s unearned income over $1,900 will be taxed at the parents’ marginal rate until the child is age 19, or age 24 for full-time students. § Noncustodial Parent Claiming Child – Starting in 2009, a noncustodial parent must attach a Form 8332 Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, or similar statement to their tax return. § 529 College Savings Plans – Starting in 2009, the definition of qualified higher education expenses includes computer technology and equipment or internet access and related services used by the 529 Plan beneficiary while enrolled in an eligible educational institution. § Infant Formula Not Deductible – PLR 200941003 concluded that infant formula could not be deducted as a medical expense and was deemed to be food purchased to satisfy the ordinary nutritional needs of a healthy child. -8-
  • 9. Individual Returns – Employment Related Issues § Employer May Accrue Medical Expenses at the Time Services are Provided – In PLR 200846021 the IRS ruled accrued amounts paid more than 2.5 months after the end of the taxable year for the prior year’s cost for a medical and dental benefit plan were deductible in the prior year (the year the medical services were provided). § COBRA Subsidies Not Taxable – 65% subsidy is not taxable. § Unemployment Benefits – For 2009, the first $2,400 of unemployment benefits received is tax free. Amounts over $2,400 are taxable. § Earned Income Tax Credit Rises – To $48,279, $45,295, $40,463, or $18,440 – respectively for families with 3 or more qualifying children, 2 or more qualifying children, one qualifying child or no children. -9-
  • 10. Individual Returns – Miscellaneous § Bankruptcy – Prince v. Commissioner, 133 T.C. No. 12 (2009) – An IRS lien, in place before taxpayer filed bankruptcy remained in effect despite discharge of taxpayer’s liability for personal tax debts. § AMT Patch – For 2009, the AMT exemption levels increased to $70,950, $46,700 and $35,475 respectively for married persons filing jointly, single persons and married person filing separately. § Mileage – For 2009, the standard mileage rate for the business use of a car, van pick-up or panel truck is 55 cents per mile. If for medical reasons or a deductible move it is 24 cents per mile. If for charitable uses it is 14 cents per mile. § Personal Casualty or Theft Loss Must be More Than $500. This does not apply to Ponzi scheme theft loss deductions. § Contract Attorney Denied Business Expense Deduction – Forrest v. Commissioner, 98 T.C.M. (CCH) 316 (2009), deduction disallowed because activity was not regular or continuous when work only lasted for a two-month period. -10-
  • 11. Return Preparers and Work Product Privilege § Electronic Filing Requirement for Return Preparers – The Worker, Homeownership and Business Assistance Act of 2009 mandates that any individual income tax return filed by a tax return preparer must be filed electronically, unless the prepare reasonably expects to file fewer than 10 individual returns during the calendar year. § Work-Product Privilege § United States v. Textron, Inc., 577 F.3d 21 (1st Cir. 2009), en banc. An in- house attorney’s tax accrual papers were not privileged when prepared to compute tax reserve and comply with securities laws, as opposed to in preparation for litigation. § Valero Energy Corp. v. United States, 103 AFTR 2d 2009-2683 (7th Cir. 2009). Holding to the extent documents are used for both preparing tax returns and litigation, such documents are not privileged. § United States v. Deloitte & Touche USA LLP, 623 F.Supp.2d 39 (D. D.C. 2009). Privilege upheld when Deloitte created memo that recorded thoughts of client’s attorney regarding the prospect of litigation. -11-
  • 12. Sale of Life Insurance Policies Treatment of Insured Owned Policies § Rev. Rul. 2009-13 – concerns the tax treatment to the insured upon the surrender or sale of whole life and term policies on his life. § Situation 1 – Upon surrender of a cash value policy the insured is treated as having ordinary income in the amount of the excess of the surrender value received over the total premiums paid. § Situation 2 – Upon the sale of the policy to an investor the insured income is measured by subtracting the policy’s adjusted basis from the sale proceeds. The adjusted basis is the total premiums paid reduced by the cost of insurance while the policy was held. -12-
  • 13. Sale of Life Insurance Policies Treatment of Investor Owned Policies §Rev. Rul. 2009-14 – concerns the tax treatment to the investor-purchaser of a policy. § Situation 1 – Upon the insured’s death the investor-purchaser excludes from income the purchase price of the policy and the additional premiums paid, but is taxable on the balance of the proceeds as ordinary income. § Situation 2 – Upon the re-sale of a policy the investor-purchaser’s gain is the excess of the sale price over the purchase price and additional premiums paid. The gain is capital gain. -13-
  • 14. Estate and Gift Tax Returns § Pay by Credit or Debit Card – Taxes due on a Form 1041 may now be paid by credit or debit card; however, a convenience fee may apply. § $3.5 Million Estate Tax Exemption for Decedents Dying in 2009. § Final Treasury Regulations Issued under I.R.C. § 2053 – The Regulations apply to estates for decedents dying on or after October 20, 2009 and explain when the IRS will allow an estate tax deduction for claims against the estate and how to determine the amount of the deduction. -14-
  • 15. “S” Corporation Returns and Other Small Businesses § Interest on Small Business Hardship Loans Excludable from Income – CCA 200943028 determined the small business borrower can exclude from gross income the interest on a loan that the Small Business Administration pays to a lender under the America’s Recovery Capital Loan Program. § One Class of Stock Rule Upheld By Fifth Circuit – The Fifth Circuit upheld the Tax Court’s decision in Minton v. Commissioner that a corporation is treated as having one class of stock if all outstanding shares confer identical rights as to distribution and liquidation proceeds – even if pro rata distributions are not made. § Deductions for Trade or Business Expenses – In Woody v. Commissioner, 97 T.C.M. (CCH) 1484 (2009), the Tax Court disallowed business deduction expenses associated with a real estate investment and rental business when taxpayer was not actively engaged in the business and property was not held out for rent during the tax year. § The IRS issued Regulations on Deemed NOL’s of S Corporations With Excluded COD Income. -15-
  • 16. Partnership and Other Pass-Through Issues § Passive Activity Loss Rules – Presumptive passive treatment of lossses is applicable to limited partners who are also general partners and to members of LLPs and LLCs where State law does not bar the entity members from participating in the entities' businesses. See Temp. Tres. Reg. § 1.469-5T; Hegarty v. Commissioner, T.C. Summ. Op. 2009-153. § Maintenance of Capital Accounts – In Robertson v. Commissioner, 97 T.C.M. (CCH) 1476 (2009) the Tax Court found, in part, that taxpayers failed to prove sufficient adjusted basis such that a distribution would not be taxable. The Court also found insufficient evidence that distributions were used to pay partnership liabilities, as opposed to personal liabilities. § Discharge of Partnership Debt – The IRS issued proposed regulations under I.R.C. § 108 providing that the fair market value of equity issued in discharge of a partnership debt is the liquidation value. The creditor would recognize no gain or loss from the exchange pursuant to I.R.C. § 721 and its capital account would be credited with the liquidation value of the interest. -16-
  • 17. Exempt Organization and Charitable Giving § Haitian Relief Contributions Made Before March 10, 2010 Deductible on 2009 Returns – H.R. 4462 allows individuals who make charitable cash contributions to aid Haitian earthquake victims to elect to claim an itemized charitable deduction on their 2009 return instead of their 2010 return. The election only applies to contributions made in cash after January 11, 2010 and before Mar ch 1, 2010. § Church Inquiries – IRS published proposed regulations under I.R.C. § 7611 that would make the Exempt Organizations Director in the IRS Tax-Exempt and Government Entities Division responsible for making the determination as to whether a church could qualify for exempt status. § Golf Course Perpetual Conservation Easement Qualifies for Charitable Contribution Deduction – In Kiva Dunes Conservation, LLC v. Commissioner, 97 T.C.M. (CCH) 1818 (2009), the Tax Court held a golf course owner was entitled to a charitable contribution deduction for a perpetual conservation easement covering the golf course. -17-
  • 18. Estate Tax Update To the surprise of many estate planners Congress did not act prior to the end of 2009, resulting in a “repeal” of the estate and GST tax for 2010. § H.R. 4154 – The House of Representatives passed H.R. 4154 to permanently extend the 2009 $3.5M exemption and 45% rate on December 3, 2009. The permanent extension passed without a single Republican vote. § The Senate Failed to Pass H.R. 4154 Before the End of 2009 – A number of Senators oppose the permanent extension and hope to get more favorable provisions such as a $5M exemption and 35% top rate. § December 31, 2009 – The House Ways and Means and Senate Finance Committees confirmed that they would not issue a letter addressing the estate tax in 2010 due to an absence of agreement on what to do. -18-
  • 19. Estate Tax Update Republicans and Democrats each have strategies with regard to estate tax legislation…we will have to wait to see which strategy prevails. § Senate Finance Committee Chairman, and long advocate of estate tax repeal, Max Baucus describes the current environment as “massive, massive confusion.” Republicans and conservative Democrats intend to use the one-year repeal as leverage to insist on larger exemptions and lower rates…certainly if repeal is intact for a year returning to a $1M exemption and 55% rate in an election year would be unacceptable. § On the flip side, Democrats feel they have leverage in the situation because 60 votes will be required in the Senate to avoid the return of a $1M exemption and 55% rate. -19-
  • 20. Estate Tax Update Democrats and Republicans also disagree as to whether an estate tax would be applied retroactively in 2010… § Representative Pomeroy, who has been heavily active in estate tax legislation proposing last year’s H.R. 436, has reportedly stated that the estate tax would not be retroactively applied to January 1, 2010. § However, Senate Finance Committee Chair Max Baucus disagrees and argues “the correct public policy is to achieve continuity with respect to the estate tax” thus claiming Congress will “clearly work to do this retroactively.” -20-
  • 21. Estate Tax Update Is retroactive legislation constitutional???? Case law suggests it would be; however, there is certainly an argument on both sides. § Untermyer v. Anderson, 276 U.S. 440 (1928) – The Supreme Court refused to retroactively apply the gift tax at its inception in 1924. Prior to the enactment of the gift tax only gifts made in contemplation of death were taxed. § U.S. v. Hemme, 106 S. Ct. 2071 (1985) – The Supreme Court upheld a retroactive rate increase and contrasted the situation to Untermyer stating “Untermyer involved the levy of the first gift tax; its authority is of limited value in assessing the constitutionality of subsequent amendments that bring about certain changes in operation of the tax laws, rather than the creation of a wholly new tax. -21-
  • 22. Estate Tax Update Is retroactive legislation constitutional???? Case law suggests it would be; however, there is certainly an argument on both sides. § U. S. v. Carlton, 512 U.S. 26 (1994) – The Supreme Court upheld the retroactive disallowance of a once allowed estate tax deduction. The Court again emphasized the limitation of the Untermyer holding stating it was limited to “certain changes in the law” distinguishing that situation from one in which there is not a “wholly new tax.” § Quarty v. United States, 83 AFTR2d ¶ 99-597 (9th Cir. 1999) – The constitutionality of a retroactive increase in the gift and estate tax rate was upheld. The taxpayer who died on January 12, 1993 was impacted by the increase enacted on August 10, 1993 but made effective as of January 1, 1993. § H.R. 4154 could play a role in retroactive legislation as tax legislation enactment is sometimes made effective as of the date that legislative proposals come out of the House Ways and Means Committee. -22-
  • 23. Estate Tax Update What is the current law? § Is “repeal” the correct term? I.R.C. § 2210 states that the estate tax “shall not apply to estates of decedents dying after December 31, 2009” except as provided in § 2210(b) regarding QDOTs. The language is the same with regard to the GST tax, I.R.C. § 2664 also makes the GST tax inapplicable to decedents dying after December 31, 2009. NOTE – neither § 2210 or § 2664 revoke the chapter of the Code imposing the estate tax and GST tax, they are still there just not applicable. § Gift Tax – The gift tax is still in effect with a $1M lifetime gift exclusion, the gift tax rate is 35% for 2010. § Carryover Basis – The basis of property acquired from a decedent is the lesser of the decedent’s adjusted basis or the fair market value of the property on the decedent’s death. I.R.C. § 1022(a)(2). Two basis step ups are available through an executor’s election - $1.3M and $3M, these will be discussed on a later slide. § Certain QDOT and Recapture provisions continue. -23-
  • 24. Estate Tax Update What is the current law? § Transfers to Non-Grantor Trusts. I.R.C. § 2511(c) applies to gifts made after December 31, 2009 and treats a transfer in trust as a transfer of property by gift, unless the trust is treated as wholly owned by the donor or the donor’s spouse. Accordingly, transfers to non-grantor trusts are presumably subject to gift tax. § The purpose of this provision is reportedly to “prevent transfers from shifting the income tax brackets applicable to investment income from the donor’s bracket to the bracket of the trust or trust beneficiaries without subjecting the transferred property to gift tax.” Akers, Estate Planning in the Shadow of the One-Year “Repeal” of Estate and GST Tax in 2010. § Notice 2010-19 – The IRS confirms that gifts to grantor trusts during 2010 may be completed gifts and states that Regulations will be issued to confirm the conclusions of the Notice. -24-
  • 25. Estate Tax Update Carryover Basis § $1.3 Million – The executor of an estate may allocate $1.3M, increased by certain unused losses and loss carryovers, to the basis of property acquired from a decedent. This is an increased basis of $1.3M and can be allocated to property passing to anyone. § $3 Million – The executor of an estate may allocate $3M to the basis of property acquired from a decedent passing to a surviving spouse, either outright or in a QTIP trust. This is an increased basis of $3M. § Practice Tip – Wills should be reviewed to ensure they contain provisions which would allow executors to make the aforementioned elections as well as provisions to exonerate the executor of any consequences that arise from the elections. -25-
  • 26. Estate Tax Update Reporting Requirements § The new I.R.C. § 6018 requires reporting of: § transfers at death of non-cash assets in excess of $1.3M § appreciated property received by the decedent that does not qualify for the basis adjustments by reason of I.R.C. § 1022(d)(1)(C) and which was required to be reported on a gift tax return. § The information that must be reported to the IRS includes the name and TIN of recipient of property, description of the property, decedent’s adjusted basis in property, sufficient information to determine if gain on sale treated as ordinary income, amount of basis increase allocated to the property, and any other information required by the Regulations. § A form has not been issued for this reporting requirement. However, penalties do apply in the case of a failure to report. -26-
  • 27. Estate Tax Update GST Concerns § Repeal – In 2010 the Generation-Skipping Transfer Tax does not apply to generation-skipping transfers. § Transfers to GST Trusts in 2010? The law is unclear as to whether allocations of the GST exemption to trusts in 2010 will lose that exemption in 2011 to the extent the election exceeds any applicable exemption present in 2011. § Payment of Life Insurance Premiums? Commentators have discussed whether a gift should be made to a GST trust during 2010, especially with regard to payment for life insurance premiums. Instead, some have recommended a sale or loan to GST trusts to cover any expenses. -27-
  • 28. Estate Tax Update Planning Recommendations § Wills – Client wills should be reviewed to ensure that they contain provisions in contemplation of the “repeal” of the estate tax. In addition, wills should contain provisions giving the executor discretion to allocate the $1.3M and $3M carryover basis adjustments and a provision to exonerate the executor with respect to such elections. § Discount Entity Planning – There is still talk of the abolishment of discounts for family limited partnerships and other non-active business entities. Therefore, clients should be encouraged to continue discount entity planning despite the current estate tax “repeal.” Although there may not be an estate tax currently, one can still be retroactively enacted and if not, it is highly likely that an estate tax will be enacted in the future. -27-

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