The federal estate tax needs to be changed, that much everyone agrees upon. Today the federal estate tax exemption is $3.5 million, which means that with some careful planning married couples can shelter $7 million from taxation over two deaths. President Obama has proposed freezing those rules, as it would keep this tax targeted to the most affluent Americans.
If Congress does nothing, current law calls for the complete elimination of the federal estate tax for 2010 only. Then in 2011 the tax comes back with only a $1 million exemption. This “nightmare scenario” has been in place since 2001, and many observers expected it to be corrected before now.
In August the nonpartisan Congressional Budget Office presented a comprehensive review of tax and spending choices to the Congressional Budget Committees. The 284-page document included an analysis of four alternatives for restoring certainty to the federal estate tax. The “cost” of each of the alternatives, in terms of projected revenue loss, was estimated based upon a comparison to current law.
Exemption Top tax rate Carryover basis? Taxable estates (in 2014) Five-year revenue cost
Alternative 1 $5 million 20% No 5,300 $128 billion
Alternative 2 $5 million 30% No 5,300 $117 billion
Alternative 3 $3.5 million 45% No 9,400 $65 billion
Alternative 4 No estate tax N.A. Yes None $163 billion
Source: Congressional Budget Office, Budget Options Volume 2, August 2009
Alternative 1 boosts the exempt amount to $5 million, adds inflation indexing, and drops the deduction for state death taxes (and does not restore the state death tax credit). In 2014, under this scenario, only 5,300 estates would be required to pay federal estate tax, compared to 58,000 under current law. The tax rate would be set equal to the top rate on capital gains, 15% through 2010 and then 20%. This approach reduces revenues by just $128 billion over the next five years.
Alternative 2 is exactly the same, but with higher tax rates. Only the first $25 million would be taxed at the capital gain tax rate, everything over that at 30%. That shaves the revenue cost to $117 billion.
Alternative 3 is similar to the President’s proposal, outlined in the budget. The exemption would be left at $3.5 million, indexed for inflation, the deduction for state death taxes would be retained, and the tax rate set at 45%. With this approach the number of taxable estates in 2014 increases by more than 50%, to 9,400, and the revenue reduction falls to $65 billion.
Alternative 4, probably the least likely to be adopted, would make the changes for 2010 permanent. That is, repeal the federal estate tax, keep the federal gift tax with a $1 million exemption, and implement carryover basis for inherited assets. This approach costs $163 billion over five years.
So what will Congress do? The leading solution, according to The Wall Street Journal, is a one-year patch, as is done with the AMT, extending the 2009 rules only into 2010. Given the politics of health care, there may not be time for deliberation on permanent estate tax reform. At least one commentator has suggested that a revenue-hungry Congress might then let the exempt amount fall back to $1 million in 2011.
(September 2009)
© 2009 M.A. Co. All rights reserved.
Tuesday, September 1, 2009
IRAs and bankruptcy
In personal bankruptcy proceedings, the general rule is that IRAs and other qualified retirement assets are protected; they not subject to the claims of the individual’s creditors. However, a recent Florida court case showed that every rule has its exceptions.
Ernest Willis filed for bankruptcy in 2007. Among his assets were a $1.2 million Merrill Lynch IRA and two smaller IRAs of less than $150,000 each. The IRAs had favorable determination letters from the IRS, which created a presumption that they would be exempt from the claims of Willis’ creditors. However, the bankruptcy court ruled that the creditors had an opportunity to rebut that presumption, which they did.
In December 1993 Willis took a $700,000 distribution from the Merrill Lynch IRA to take care of a delinquent mortgage on property that he owned with his wife. The money was returned to the IRA in February 1994, 64 days later. Had the money been restored to the IRA within 60 days, there would have been no problem. However, because Willis crossed the 60-day line, the bankruptcy court ruled that the loan was a prohibited transaction, one that cost the IRA its tax-qualified status. The entire $700,000 should have become a taxable distribution, and the redeposit of the money should have been penalized as an excess contribution. However, the IRS never noticed the problem. Nevertheless, the bankruptcy court now holds that because the IRA ceased being a qualified retirement plan in 1993, it was no longer a protected asset in bankrupcy.
What’s more, in 1997 Willis made a series of eight transfers between his regular brokerage account and the Merrill Lynch IRA. Transfers from the IRA were all returned to it within 60 days, but the tax law allows for only one 60-day rollover per year. The Court held that this “check-swapping” scheme also amounted to prohibited borrowing from the IRA, so that if the IRA hadn’t become invalid in 1993, it certainly did become so in 1997.
The other two IRAs were traceable to funds received from the Merrill Lynch IRA after 1997, so they were similarly unprotected.
The statute of limitations has run for the 1993 and 1997 tax years, so the IRS isn’t likely to get the tax money that arguably came due then. But the shield created by the lapse of time with respect to the tax claims offers no protection in the bankruptcy context. Thus, it’s important to handle tax-qualified assets with utmost care, to be certain that they will be available during retirement.
(September 2009)
© 2009 M.A. Co. All rights reserved.
Ernest Willis filed for bankruptcy in 2007. Among his assets were a $1.2 million Merrill Lynch IRA and two smaller IRAs of less than $150,000 each. The IRAs had favorable determination letters from the IRS, which created a presumption that they would be exempt from the claims of Willis’ creditors. However, the bankruptcy court ruled that the creditors had an opportunity to rebut that presumption, which they did.
In December 1993 Willis took a $700,000 distribution from the Merrill Lynch IRA to take care of a delinquent mortgage on property that he owned with his wife. The money was returned to the IRA in February 1994, 64 days later. Had the money been restored to the IRA within 60 days, there would have been no problem. However, because Willis crossed the 60-day line, the bankruptcy court ruled that the loan was a prohibited transaction, one that cost the IRA its tax-qualified status. The entire $700,000 should have become a taxable distribution, and the redeposit of the money should have been penalized as an excess contribution. However, the IRS never noticed the problem. Nevertheless, the bankruptcy court now holds that because the IRA ceased being a qualified retirement plan in 1993, it was no longer a protected asset in bankrupcy.
What’s more, in 1997 Willis made a series of eight transfers between his regular brokerage account and the Merrill Lynch IRA. Transfers from the IRA were all returned to it within 60 days, but the tax law allows for only one 60-day rollover per year. The Court held that this “check-swapping” scheme also amounted to prohibited borrowing from the IRA, so that if the IRA hadn’t become invalid in 1993, it certainly did become so in 1997.
The other two IRAs were traceable to funds received from the Merrill Lynch IRA after 1997, so they were similarly unprotected.
The statute of limitations has run for the 1993 and 1997 tax years, so the IRS isn’t likely to get the tax money that arguably came due then. But the shield created by the lapse of time with respect to the tax claims offers no protection in the bankruptcy context. Thus, it’s important to handle tax-qualified assets with utmost care, to be certain that they will be available during retirement.
(September 2009)
© 2009 M.A. Co. All rights reserved.
Card check
The Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 was signed by President Obama last May, after passing both Houses of Congress by wide, bipartisan margins. The law provides for a number of changes that credit card holders will welcome:
• When multiple interest rates apply to the same credit line, payments will apply first to the balance with the highest interest rate, the opposite of past practice.
• A minimum of 21 days must be allowed to pay a bill.
• Card contracts must be available online, not just sent as fine-print forms to cardholders.
• At least 45 days’ notice must be given before the APR is increased.
• New restrictions apply to providing cards to those under 21. In many cases, a parent will be required to cosign for the card.
The restrictions for younger cardholders were included based upon evidence that many college students have been having trouble handling their debt, getting in over their heads. On the other hand, there is some concern that young people will have a harder time establishing their own independent credit histories once the new rules take effect.
That doesn’t happen until February 22, 2010. The delayed implementation date gives credit card companies time to adjust to the new requirements. Some of the adjustments include taking a much more conservative approach to issuing credit. Some cardholders have found their credit limits reduced, sometimes unexpectedly. A big decline in the use of “teaser rates” is expected.
These developments are a predictable response given the prospective curtailment of profit opportunities for the card issuers.
It will be important to monitor communication from card companies during the coming months. Best of all, implement a plan to pay down debt aggressively, strengthening your financial foundation and reducing your vulnerability to shifts in the economic winds.
(September 2009)
© 2009 M.A. Co. All rights reserved.
• When multiple interest rates apply to the same credit line, payments will apply first to the balance with the highest interest rate, the opposite of past practice.
• A minimum of 21 days must be allowed to pay a bill.
• Card contracts must be available online, not just sent as fine-print forms to cardholders.
• At least 45 days’ notice must be given before the APR is increased.
• New restrictions apply to providing cards to those under 21. In many cases, a parent will be required to cosign for the card.
The restrictions for younger cardholders were included based upon evidence that many college students have been having trouble handling their debt, getting in over their heads. On the other hand, there is some concern that young people will have a harder time establishing their own independent credit histories once the new rules take effect.
That doesn’t happen until February 22, 2010. The delayed implementation date gives credit card companies time to adjust to the new requirements. Some of the adjustments include taking a much more conservative approach to issuing credit. Some cardholders have found their credit limits reduced, sometimes unexpectedly. A big decline in the use of “teaser rates” is expected.
These developments are a predictable response given the prospective curtailment of profit opportunities for the card issuers.
It will be important to monitor communication from card companies during the coming months. Best of all, implement a plan to pay down debt aggressively, strengthening your financial foundation and reducing your vulnerability to shifts in the economic winds.
(September 2009)
© 2009 M.A. Co. All rights reserved.
Ask a trust officer: Blended families
DEAR TRUST OFFICER:
I’m planning to remarry, and I know that means I should take a look at my will. Right now I’ve left my property to my kids from my first marriage. I’d like to include my new spouse in my plan, yet I don’t want to cut out the children completely. Is there an easy solution?
—STARTING OVER
DEAR STARTING:
In situations such as yours, we’ve seen a lot of interest in the Qualified Terminable Interest Property Trust, or more commonly, QTIP Trust. The trust is “qualified” for the marital deduction from the federal estate tax, provided the surviving spouse is a U.S. citizen. The trust is “terminable” because it ends at the spouse’s death, and the spouse usually doesn’t have the right to change who gets the property at that point. In other words, the inheritance for your children is secure.
Another benefit of the QTIP trust is that the executor can elect a full or partial marital deduction, depending upon what’s best for tax purposes. That flexibility is especially welcome during these times when the federal estate tax may be undergoing major changes.
Do you have a question concerning wealth management or trusts? Send your inquiry to [trustofficer@bankname.com].
(September 2009)
© 2009 M.A. Co. All rights reserved.
I’m planning to remarry, and I know that means I should take a look at my will. Right now I’ve left my property to my kids from my first marriage. I’d like to include my new spouse in my plan, yet I don’t want to cut out the children completely. Is there an easy solution?
—STARTING OVER
DEAR STARTING:
In situations such as yours, we’ve seen a lot of interest in the Qualified Terminable Interest Property Trust, or more commonly, QTIP Trust. The trust is “qualified” for the marital deduction from the federal estate tax, provided the surviving spouse is a U.S. citizen. The trust is “terminable” because it ends at the spouse’s death, and the spouse usually doesn’t have the right to change who gets the property at that point. In other words, the inheritance for your children is secure.
Another benefit of the QTIP trust is that the executor can elect a full or partial marital deduction, depending upon what’s best for tax purposes. That flexibility is especially welcome during these times when the federal estate tax may be undergoing major changes.
Do you have a question concerning wealth management or trusts? Send your inquiry to [trustofficer@bankname.com].
(September 2009)
© 2009 M.A. Co. All rights reserved.
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