If you want to believe that the lame-duck Congress will come to the rescue after Election Day and renew the Bush-era tax cuts, return the estate tax to its more palatable 2009 levels and increase the exemptions from the alternative-minimum tax, go ahead
If you want to believe that the lame-duck Congress will come to the rescue after Election Day and renew the Bush-era tax cuts, return the estate tax to its more palatable 2009 levels and increase the exemptions from the alternative-minimum tax, go ahead.
The rest of us will get ready for the worst — a tsunami of tax increases that will make most Americans miserable.
Recent history is on our side.
Consider the estate tax. Congress had nine years to figure out what a new estate tax should look like. Instead, it let the estate tax lapse for 2010, something no one expected and few thought made sense — except those wealthy families such as the Steinbrenners, whose tax bill was reduced substantially when their patriarch passed away this year.
Attorney Joshua S. Rubenstein, national chairman of trusts and estates at Katten Muchin Rosenman LLP, said it was an “incredible irresponsibility” on the part of Congress to let the estate tax expire at the end of 2009.
“Nobody expected that Congress would never touch the law, and it's staggering to see what the elimination of the estate tax has done to the economy,” said Mr. Rubenstein. “At least five billionaires have died this year in the U.S. The revenues Congress lost from their estates — billions and billions of dollars — are just huge!”
Other billionaires besides George Steinbrenner who passed away include Mary Janet Cargill ($1.7 billion), Dan Duncan ($9 billion), Walter Shorenstein ($1.1 billion), and John Kluge ($6.5 billion.) At the top 45% rate in place last year for estates exceeding $3.5 million, those five families alone would have paid $8.7 billion in estate taxes this year if Congress had not allowed the tax to expire.
With so little time left before the year ends, tax professionals agree it is unlikely Congress will enact any retroactive legislation. Attempting to recoup some of those lost billions in estate taxes, for example, would only generate legal challenges by heirs who can afford the litigation.
By doing nothing, Congress will let the estate tax revert to pre-2001 levels, with a top rate of 55% and a $1 million exemption.
INCOME TAX
Congressional inaction will also affect income tax rates, which would return to where they were before the Economic Growth and Tax Relief Reconciliation Act of 2001 — 15%, 28%, 31%, 36%, and 39.6%.
However, the president may prevail in his proposal to retain the current lower bracket rates of 10%, 15%, 25% and 28% but allow the two top rates of 33% and 35% to go back up to 36% and 39.6%.
There is also the possibility that the Republicans will score victories in the midterm elections this week and successfully extend the Bush-era tax rates for everyone.
Let's assume that at the very least, upper-income Americans — defined as individuals with adjusted gross income of $200,000 or more and couples making $250,000 or more — get socked with higher taxes. What would the effect on those taxpayers be?
Mark Luscombe, principal analyst for CCH Inc., a global provider of tax and accounting information to professionals specializing in the field, provided InvestmentNews with this illustration:
Assume a married couple with no children, who file a joint return and take the standard deduction. They have $300,000 in wage income, $50,000 in net capital gains and $5,000 in dividend income (for this illustration, no inflation adjustments were made for 2011 from 2010 bracket amounts). Their tax liability will go up $12,929, to $91,789, from $78,860, if the Bush-era tax cuts expire. If Mr. Obama's proposal is adopted, the couple will see their tax liability rise $5,151 to $84,011.
Another result of the expiration of the Bush-era tax cuts would be a revival of the so-called marriage penalty. Under the 2001 tax bill, the standard deduction for a married couple filing a joint return gradually increased to twice that of an unmarried single filer. If the law is allowed to expire, the $11,400 deduction applicable in 2010 will drop to somewhere between $9,500 and $10,000 in 2011.
PATCHING THE AMT
Unless Congress takes action before year-end, alternative-minimum-tax exemptions will expire, returning qualifying amounts back to 2001 levels. This has been the first year since 2005 that Congress has failed to enact a patch adjusting these figures, meaning that exemption amounts for 2010 and 2011 will fall to $33,750, from $46,700 for unmarried single filers, and to $45,000, from $70,950, for married couples filing a joint return.
“It would be a political disaster not to increase even slightly the exemption from the AMT,” said Julian Block, an attorney who conducts continuing-education courses for financial planners and the author of several books on taxes.
Should nothing be done, he estimates that 30 million individuals would become subject to the AMT.
“That's not going to happen,” he said. “We'll see a one-year patch, but there won't be a substantial overhaul. Changing the AMT [by a significant amount] would exponentially increase the deficit.”
In terms of the percentage change, the largest tax hike is the rate on dividends, which — along with capital gains — have been taxed at 15% since the Jobs and Growth Tax Relief Reconciliation Act of 2003. A return to pre-Bush tax cut rules means that dividends will be taxed as ordinary income, with rates as high as 39.6% — close to a 250% increase. While the same fate awaits short-term capital gains — rates are currently capped at 35% — rates on long-term capital gains are expected to climb only to 20%.
But even that small increase could affect estate taxes, which this year — to offset losses from the 2010 suspension — underwent a change from step-up to carry-over basis. While it would take new legislation to retain the carryover rule to 2011 and beyond, an extension would hit heirs of large estates hard, while burdening executors.
Mr. Rubenstein explains: “Carry-over basis will be very hard to figure out and be subject to income tax. It will be even harder to track then, because income tax returns are audited more rarely than estate tax returns.”
Neither Congress nor President Barack Obama has addressed the basis question.
Gail Cohen, vice chairman and general trust counsel at Fiduciary Trust Company International, said: “We could end up with no estate tax in 2010 and a return to step-up in 2011, which many people think might be too good to be true.”
It's that kind of anomaly that concerns certified financial planner Eric Seff of Seff Investments LLC, a fee-based firm that manages up to $30 million in assets.
He has been trying to identify the worst-case scenario for his clients. “Assuming the cuts are all repealed or repealed for those with incomes above a certain level, it's not a happy situation. And if the taxes on dividends and capital gains go up, it won't be happy for anyone,” he said.
“On the other hand,” he said, “if you look at the finances of the federal government, we need the money.”
