Written By: Thomas L. Hausman
Schneider, Smeltz, Ranney & LaFond, LLP
Tax planning for the end of 2010 and the years ahead are particularly difficult because of the present uncertainty in the law. The Bush tax cuts are due to expire at the end of 2010, and the estate tax will revert back to the same as it was before 2001. Congress can enact legislation to prevent or modify the scheduled change in the law, but so far, it has shown little interest (or ability) in doing so. Many people feel Congress has committed “legislative malpractice” by not acting on these expiring tax provisions. In view of the need for more money for the government, tax increases may be enacted by Congress in order to finance the deficit.
If Congress does nothing, there will be a tax increase in the top tax rates from 33% and 35% to 36% and 39.6%. (For married couples filing a joint return, the tax rate for taxable income between $140,000 and $250,000 will be increased from 33% to 36%, and for taxable income over $250,000, the rate will be increased from 36% to 39.6%. For an unmarried individual, the rate will be 36% of taxable income between $115,000 and $250,000, and will be 39.6% for taxable income over $250,000.)
The capital gains tax rate is also scheduled to increase from 15% in 2010 to 20% in 2011. The rate on dividend income will also be increased from its current rate of 15% to as high as 39.6%.
In 2009, Congress amended section 529 to provide that a taxpayer having a section 529 plan could use money in the plan during 2009 and 2010 to pay for a computer or software, provided the beneficiary is enrolled at an eligible educational institution.
With regard to estate and gift tax planning, there is no estate tax for 2010, so a taxpayer who dies in 2010 will owe no estate tax. Likewise, there is no generation skipping transfer (GST) tax in 2010. However, the lifetime gift tax exclusion is $1 million. The 2010 top tax rate on taxable gifts is 35%, but the rate will increase in 2011 to 55%.
In the meantime, what should taxpayers do to enhance their tax situation?
We have a few suggestions.
1. If all other factors are equal, and if it is possible to do so, it may be a good year to accelerate income into 2010 instead of deferring it to 2011 and later. This is because tax rates will increase next year and beyond. Accelerating income into 2010 may not be the right decision for every taxpayer. There can be a large benefit to deferral of income as well, so you will have to give some thought as to whether it is better to defer or accelerate. Since we don’t know what the tax rates will be in the future, this may be an even more difficult decision.
Now may be a good year to sell capital assets in order to take advantage of the 15% tax rate instead of the increased rate of 20%. If you have some potential tax losses from your stock holdings, you may want to defer them to 2011 and use them to offset capital gains in 2011.
In view of the increased tax on dividend distributions, 2010 would be a good year for a C corporation to distribute dividends.
2. Defer deductions if possible to 2011 and beyond. As the tax rates increase, so does the value of your deductions. Generally, the tax savings from a deduction will equal the taxpayer’s tax rate multiplied by the amount of the deduction. As income tax rates increase, so will the tax savings from deductions.
You must be careful, however, with respect to deferring deductions into 2011 and beyond. The Internal Revenue Code imposes certain restrictions on the allowance of itemized deductions. In the future, there may be more severe restrictions on the allowance of itemized deductions, and you must also consider the alternative minimum tax in making this determination.
For those taxpayers who desire to purchase depreciable property, the Small Business Jobs Act of 2010 (the “Jobs Act”) provides some relief. In general, under section 179 of the Code, a taxpayer can deduct the cost of “qualifying property” up to $250,000 in 2010, but this amount is phased out to the extent that the cost of the qualifying property exceeds $800,000. Thus, instead of depreciating the property over a period of years, the taxpayer can immediately deduct it in the year the property is placed in service. Under the new law, for 2010 and 2011, a taxpayer can expense the cost of purchasing depreciable property up to $500,000, and the phase-out amount is increased from $800,000 to $2 million. In addition, certain types of real property will constitute “qualifying” property under section 179. Specifically, qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property will constitute section 179 property. In order to qualify under section 179, the property must be acquired by purchase. The amount of the expense under section 179 cannot exceed the taxpayer’s taxable income derived from the taxpayer’s active conduct of a trade or business during the year.
Other taxpayers will choose to not use the accelerated write-off of Section 179. Instead, they will choose to depreciate the capital or section 1231 asset over the prescribed time period because income tax rates will be higher in 2011 and beyond.
The Jobs Act also permits a taxpayer to deduct additional first year depreciation for property acquired in 2010. The Jobs Act extended the prior law which would otherwise have expired at the end of 2009, except for certain transportation property and long-lived property. The amount of the additional first year depreciation is 50% of the adjusted basis of qualified property. There are certain requirements for the allowance of additional first year depreciation.
3. With regard to estate and gift taxes, those people with wealth may wish to make gifts of appreciated property in 2010, even if it results in gift taxes being paid. This may be especially true for those people desiring to make gifts to grandchildren or trusts for grandchildren and more remote lineal descendants. Since there is no GST tax, outright gifts to grandchildren could provide a substantial benefit. Gifts in trust for the benefit of grandchildren could be more problematic. The maximum gift tax rate is only 35%, but it will increase next year to 55% unless Congress amends the gift and estate tax laws.
It is quite often beneficial from a tax viewpoint to make lifetime gifts rather than making bequests of property at death. One reason is that the gift tax is “tax exclusive” whereas the estate tax is “tax inclusive.” For example, assume that Mr. A has a taxable estate of $1.5 million. For ease of computation, assume the entire amount of $1.5 million is subject to the estate tax, and also assume, again for simplicity, that the tax rate is 50%. If Mr. A transfers $1 million to his son, he will incur a gift tax of $500,000. If Mr. A holds the property until his death, assume his taxable estate will be $1.5 million. He will pay $750,000 in estate taxes, and he will have only $750,000 left for distribution to his heirs. Mr. A was better off (by $250,000) by making a gift of $1 million and paying the gift tax. By including the property in his estate, he paid $250,000 more in taxes. Regardless of the rate of tax, it is often beneficial from a tax viewpoint to make gifts rather than to die owning the property.
It often makes good sense to make annual gifts equal to the amount of the annual exclusion, which is $13,000 for 2010 and 2011. With a split gift (a gift made by both a husband and wife, even if the proceeds come from only one spouse), the taxpayer can give away $26,000 per year per donee. The annual exclusion is a “use it or lose it” benefit. If you can afford to make annual exclusion gifts, we recommend you use it.
This paper is not intended to be exhaustive on the subject matter nor to provide legal advice to the reader.