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I hope you all had a wonderful holiday season, and are enjoying the lovely Chicago weather this winter.
We are getting geared up for tax season - the tax organizer packages have all gone out in the mail (they were mailed between 1/11th and 1/15th). If you haven't received yours, please contact Kristy (ext. 10) or Peggy (ext. 19) and they can get you a replacement package.
As you may have heard, Congress did not complete tax legislation to amend the estate tax laws by December 31st. This means that currently, there is no estate tax. But beginning next year, in 2011, the estate tax comes back, and with a vengeance. In 2011, the estate tax exemption will be $1,000,000 (the exemption was $3,500,000 last year), and rates will be higher.
You'll find below a discussion of some of the many laws and provisions that were changed last year, along with some of the unfinished legislation. I've also included an article I hope you'll find interesting, having to do with market predictions.
If you know anyone who could benefit from our services, we would be happy to meet with them. We will review their prior year's tax return, and provide them with an organizer package to get them setup for handling their 2009 income taxes. No fee, no obligation.
As always, please contact us if you have any questions about these issues, or any concerns you have about taxes or finances.
Bob Rounsfull
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Roundup of 2009 tax developments- New laws, IRS changes and judicial decisions
There were a number of important tax developments in 2009, and while the tax law changes in the American Recovery and Reinvestment Act of 2009-and to a lesser extend in The Worker, Homeownership, and Business Assistance Act of 2009 and other tax laws-got the most attention, many other IRS and court developments occurred that may significantly affect you. With the year just over, it's a good time to review the changes in the tax landscape, and consider the unique opportunities and challenges that these changes may provide.
Enacted tax legislation. The federal government's high-gear crisis management approach to a complex economic crisis dominated the legislative agenda during 2009. That dominance carried over to major legislative tax developments in 2009, as Congress passed laws making significant, but short-term, tax changes in an effort to stimulate the economy and help businesses and individuals weather the economic storm:
The American Recovery and Reinvestment Act of 2009 (ARRA, PL 111-5, 2/17/2009). Business changes included extended bonus depreciation and increased expensing, longer NOL carrybacks for electing small businesses (ESBs), and deferral of debt discharge income from reacquisitions of certain business debt. Changes for individuals included a 65% subsidy for COBRA continuation coverage on account of involuntary termination (tax-free on receipt, but recaptured by those with higher income), a refundable tax credit phasing out at higher levels of income, a beefed-up higher education tax credit, an enhanced and liberalized credit for first-time homebuyers and a tax deduction for state sales and excise taxes paid on the purchase of new vehicles. ARRA also patched the AMT problem for 2009 only.
The Worker, Homeownership, and Business Assistance Act of 2009 (PL 111-92, 11/6/2009). Business changes included allowing most business to carry back NOLs for 3, 4, or 5 years, extension of the FUTA surtax, and a delay in the application of worldwide allocation of interest. Changes for individuals included an extension and liberalization of the first-time homebuyer tax credit, including allowing the credit to be claimed by existing homeowners who are "long time residents."
The Department of Defense (DOD) Appropriations Act of 2010 (P.L. 111-118, 12/19/2009). The DOD Act extended the 65% COBRA premium subsidy that was enacted by ARRA. It added another six months to the maximum period that the COBRA subsidy can run, and extended the subsidy to workers (and their eligible family members) who lose their jobs during the first two months of 2010 (under ARRA, those losing jobs after 2009 wouldn't have been eligible).
Unfinished tax legislation. A number of bills that seemed all but certain to pass before the end of 2009 failed to do so. However, it seems likely that action on these bills is merely postponed and that they will be enacted in 2010.
Health care reform. The House and the Senate passed separate versions of healthcare reform legislation before the close of 2009, with the expectation that the bills will be reconciled early in 2010. Healthcare reform legislation would make significant, far-reaching tax. For example, the House healthcare bill would place a 5.4% surcharge on income over $500,000 ($1 million for joint filers), but the Senate bill would subject so-called "Cadillac" group health coverage to a 40% excise tax, place an additional 0.9% Medicare HI payroll tax on wages over $200,000 ($250,000 for joint filers), and hit certain segments of the health industry with fees. Both bills would place a $2,500 cap on health flexible savings accounts (FSAs), increase penalties on nonqualified distributions from health savings accounts (HSAs), and provide that the cost of over-the-counter medicine (other than insulin or doctor prescribed medicine) could not be reimbursed through a health FSA, HSA, or Archer medical savings account (MSA).
Extenders. The "Tax Extenders Act of 2009," passed the House of Representatives on Dec. 9, 2009, but was not taken up by the Senate before year end. The House bill would extend for one year 40-plus tax provisions that expired at the end of 2009, including: the research tax credit; the active financing exception from Subpart F of the Code; the current law look-through treatment of payments between related controlled foreign corporations; fast writeoffs for some specialized assets; the election to take an itemized deduction for State and local general sales taxes in lieu of the itemized deduction for State and local income taxes; the additional standard deduction for State and local real property taxes; and the above-the-line tax deduction for qualified tuition and related expenses. Most observers expect Congress to pass extender legislation in 2010.
Estate and gift taxes. The final important piece of unfinished legislative business was an estate and gift bill. On Dec. 3, 2009, the House of Representatives passed H.R. 4154, the "Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Act of 2009." The bill would make permanent the estate, gift, and generation skipping transfer (GST) tax laws that were in effect for 2009. The Senate, however, did not take up the bill before year-end. Consequently, estate and gift tax currently are in a state of limbo. Under changes made by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the estate tax and the GST tax are repealed for estates of decedents dying in 2010 and a modified carryover basis regime applies for 2010; and tough estate and gift rules are slated to return for estates of decedents dying after 2010. However, most observers believe Congress will enact a "patch" of sorts that would retroactively reinstate estate and gift taxes for 2010. Treasury and IRS guidance. The 2009 year featured the usual flood of rulings, revenue procedures, notices, and regulations, and other guidance. Business topics addressed included: relaxed net operating loss (NOL) carryback rules; forgoing bonus depreciation to gain refundable credits; tax return preparer penalties; foreign contract manufacturing arrangements; corporate inversion transactions; cost-sharing arrangements; intercompany transactions; controlled services transactions and the allocation of income from intangible property; controlled group qualification rules; consent to treat intercompany transactions on a separate entity basis; conversions of partnerships to corporations; S corporation tax attribute reduction for cancellation of debt (COD) income; and how to elect deferral of COD income on repurchased debt. Benefits related subjects included: employer-owned life insurance contract; stock options issued under an employee stock purchase plan (ESPP); Code Sec. 401(k) automatic contribution arrangements, and suspension of Code Sec. 401(k) safe harbor nonelective contributions for business hardship. Other guidance topics included: nonbusiness energy credit; election to claim the reduced research credit; the limited-time COBRA premium subsidy; waiver of required minimum distributions for 2009; first-time homebuyer tax credit; energy saving credits for homeowners; the exclusion from gross income for amounts received on account of personal physical injuries or physical sickness; private foundations and sponsoring organizations that maintain donor advised funds; qualified plan to Roth IRA rollovers; and determining the amount deductible for estate tax purposes as a claim against the estate.
Additionally, during 2009, Treasury and IRS undertook a number of important initiatives, such as: limited-time suspension of the Code Sec. 6707A penalty for smaller transactions; tax guidance and some limited tax relief for victims of Madoff-type investment schemes; a settlement offer for those that voluntarily and timely disclosed unreported offshore income; negotiation of an agreement to release information on U.S. holders of accounts at UBS AG (Switzerland's largest bank); regulations on when basis overstatement triggers a 6-year period for assessing tax and the minimum period for assessment of tax attributable to partnership items; and a new initiative to boost retirement savings.
Judicial developments. Noteworthy among the many 2009 court decisions dealing with taxes wereTextron, holding that a corporation's tax accrual workpapers aren't protected by the work product privilege,Xilinx, accepting IRS's Code Sec. 482 treatment under prior regulations of employee stock options under a taxpayer's cost-sharing arrangement with its subsidiary, andGarnett, holding that interests in limited liability partnerships (LLPs) and limited liability companies (LLCs) weren't presumptively passive under the passive activity rules. On the tax shelter front, IRS lost big inConsolidated Edison Company (lease-in, lease-out transaction was found to have economic substance) but won big inTIFD II-E, Inc. (tax shelter involving income allocated to foreign partners).Taproot Administrative Services held that a Roth IRA is not an eligible S corporation shareholder, several decisions found that use of a qualified intermediary doesn't avoid the like-kind-exchange related party rule,Pierre upheld favorable gift-tax valuation of transfers of interests in a single member LLC, andMayo Foundation upheld FICA student exception regulations and held that medical residents were liable for FICA tax.
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Shaky Predictions
It's a good thing that financial planners and advisors aren't paid to predict the future because, well, nobody seems to be doing a very good job of it lately. I hope you'll remember this as all the major financial magazines come out with their yearly "Here's what will happen in 2010" cover stories.
Reading through some back issues, we find that at this time two years ago, nobody, anywhere, was predicting a 4th quarter meltdown in the investment markets, or the global economy tottering on the edge of disaster. In fact, not a one of the prognosticators seems to have realized that the U.S. economy had already fallen into a recession.
If you read the magazine issues in early September, right before the markets suddenly went into a 400-point free-fall in two trading days (triggered, you probably remember, by the collapse of Lehman Brothers, the AIG bailout and the federal rescue of Fannie Mae and Freddie Mac), you realize that nobody had a clue that a storm was brewing on the horizon. The Wall Street Journal talked confidently about Lehman's efforts to secure a line of credit or divest some assets, and the consensus seemed to be that the damage from the burst housing bubble had been safely contained. Postmortem articles about the crisis show that the Federal Reserve Chairman Ben Bernanke and Treasury Secretary Hank Paulson, who both watch the economic numbers DAILY, were caught totally flat-footed.
Closer to home, in January of 2009, economists and pundits were talking about the possibility of a sustained market drop similar to the slow investment torture the Japanese have experienced since 1989. Kiplinger's magazine identified the people who had been most right in their 2008 predictions and asked them what they thought was going to happen in 2009. Not a one of them predicted what actually happened: a dramatic rise in stock prices (the S&P 500 touched bottom on March 6 with an intraday price of 666.79 and rose to over 1,100 currently), a sharply rising dollar and an end to the economic recession--what economists are now describing as a jobless recovery.
Here's what they actually said. David Tice, chief equity strategist for Federated Investors, told the magazine's readers that "The dollar will decline, and it's very possible that inflation will pick up. The S&P 500 index could easily fall to 450 or so. This will be a longer-term decline," he added, and gave the worst advice possible for investors over the next three quarters, saying that "Investors should be selling equities and conserving cash."
Bob Rodriguez and Tom Atteberry, of First Pacific Advisors, confidently predicted that: "The upturn won't come until 2010, and when it does, it will look very sluggish and lethargic."
Economist Nouriel Roubini told Kiplinger readers: "I expect that the recession will be very severe and that it won't be over before the end of 2009. I think there is a further 15% to 20% downside risk for global and U.S. stocks, and a further 15% to 20% downside risk for commodity prices. So 2009 will be a year of recession and deflation."
Peter Schiff, president of Euro Pacific Capital, missed the appreciation of the dollar, the dramatically low interest rates and the economic recovery--all in a couple of sentences. "The dollar is going to resume its fall," he said, "leading to a resurgence in the bull market in commodities. That will pierce the bubble in the bond market, causing interest rates to go up. So we're going to be in a depressionary environment, but with rising prices and rising interest rates. Our economy will be a mess for years and years to come."
The worst advice was being given right at the bottom in March, when global stock prices were about to reward patient investors with an amazing rally. Consider this evaluation from the March 5 issue of Business Week magazine:
All told, more than $10 trillion of stock market wealth has vanished, and with it the confidence that springs from financial security. "We are looking at a 60% to 70% chance that this bear market is not over," says Robert D. Arnott, chairman of Research Affiliates, a Pasadena (Calif.) firm that manages $25 billion.
The article went on to predict "more debt busts and government trial and error until things get set right again. That could mean two more years of bouncing around and then another six or so before the Dow is back above 14,000. Not long ago, such an outcome would have seemed unimaginably bleak. Given the other possibilities, it doesn't seem so bad now."
The hardest part about investing is controlling the natural urge to sell when the market has cratered, or to buy when the market is euphoric. But that's like going to the mall and waiting to buy until all the sales are over and prices have gone up, and then, as soon as the store has its next 25% off sale, going back and selling whatever you bought. Nobody would even think of doing that with their holiday gift purchases, but it's normal behavior in the investment markets.
The unhappy truth is that nobody can foresee the future, and the investment markets tend to be far less predictable than other areas of our lives. Like it or not, we venture blindly forth every day, control what we can control (investment costs, taxes and savings rates), and generally make more money in the
upturns than we do in the downturns. Years ago, a pundit threw up his hands and said: "I don't know what the markets will do tomorrow, or next week, or next month. But I do know, with certainty, which direction the next 100% movement in the markets will be."
There, finally, is a prediction I can endorse.
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The federal estate tax is dead--at least for now.
It's 2010, and the temporary, one-year repeal of the federal estate tax is in effect. The failure of Congress to either extend the 2009 estate tax rules into 2010 or enact a permanent estate tax law has created several unfortunate consequences. Here are some things you need to know to protect your family and your assets.
Facts
 Both the federal estate tax and the federal generation-skipping transfer tax (a separate tax on property given to grandchildren, great-grandchildren, etc.) are repealed for 2010 (unless Congress enacts legislation to reinstate them, retroactive to January 1, 2010 or otherwise).
Both taxes are scheduled to return in 2011 at levels that applied prior to 2001; that means a $1 million exemption and a top tax rate of 55% (in 2009, the exemption was $3.5 million and the top rate was 45%).
The federal gift tax remains in effect with a $1 million lifetime exemption, and the top tax rate is 35%.
The step-up in basis rule that allowed heirs to inherit property with a fair market value as of the date of death of the decedent has been modified. For 2010, the basis for inherited property is the lesser of the decedent's basis (carryover basis) or its fair market value on the date of death. But, $1.3 million of estate property is afforded a step-up in basis, and up to $3 million of property passing to a surviving spouse receives a step-up as well.
What's next?
It's anyone's guess what Congress will do next. Some believe quick action will reinstate the taxes at 2009 levels (see above). Others believe Congress will proceed cautiously in an attempt to enact serious reform. In either case, any reinstated tax may or may not be made retroactive to January 1, 2010. Needless to say, planning under these circumstances is challenging, at best.
The fallout
If your estate plan assumed that an estate tax would be imposed in 2010, it may no longer carry out your intentions; it may not provide adequately for your spouse, and it may not meet your overall tax objectives. Here are some steps you may want to take.
See your estate planning attorney about the possible need to revise your will, trust, and other estate planning documents, especially if they include formula clauses. A formula clause expresses certain bequests in terms of fractions or percentages in order to eliminate or reduce estate taxes. You may also need to see your estate planning attorney about these documents if you live in a state that imposes its own estate and/or inheritance tax, or if your documents include multi-generational planning.
Organize your records and get your parents/grandparents to organize theirs. The modified carryover basis rules impose strict reporting requirements, including supporting documentation and penalties for noncompliance.
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