Tax Relief Act of 2010: Planning for 2010 and 2011

Provided by Wells Fargo.

On December 17, 2010, President Obama signed H.R. 4853, The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “Tax Relief Act of 2010” or the “Act”). By signing this bill into law, the President put definition around the tax uncertainty that had been plaguing wealth planners and their clients in 2010.

Key provisions.

The Act covers the following important tax considerations as well as a few others:1. Extension of Bush-era tax cuts for all taxpayers for 2011 and 2012.

• Ordinary income: Current individual income tax rates will remain in place with a top rate of 35 percent.
• Capital gains: The top rate on long-term capital gains (LTCG) will remain at 15 percent.
• Dividends: The rate on qualified dividends will remain at 15 percent.

2. Estate tax relief for 2011 and 2012.

• Estates in 2011/2012: Estates in excess of $5 million (per individual and indexed for inflation after 2011) will be subject to a top estate tax rate of 35 percent in 2011 and 2012.
• Estates in 2010: The new estate tax rules will also be retroactive to the beginning of 2010. However, estate executors will be allowed to elect to have the former 2010 rules (no estate tax and limited carryover basis of $1.3 million with an additional $3 million for assets transferred to a surviving spouse) apply to estates of those who passed away in 2010.

• Portability: Starting in 2011, any unused exemption remaining from the estate of one’s last deceased spouse may be applied to the surviving spouse’s estate to be used upon his/her death, provided the second death occurs before 2013. In other words, the first-to-die spouse’s exemption is “portable.” The portability of the exemption requires that an election be made on the deceased spouse’s estate tax return, whether or not such a return would otherwise be required. Note: Portability only applies for deaths after 2010 and does not apply to the generation skipping tax (GST) exemption.

3. Gift and GST taxes.

• Gifts in 2011/2012: The gift tax rate will remain at 35 percent for 2011 and 2012 with a unified lifetime gift and estate tax exemption of $5 million (adjusted for inflation starting in 2012).

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• GST: The GST tax rate will be set at zero percent for 2010 and will be 35 percent for 2011 and 2012 with a $5 million lifetime exemption (adjusted for inflation starting in 2012).
• Portability: Starting in 2011, donors may apply any unused exemption from their last deceased spouse to gifts made during their lifetime (provided the first spouse dies after 2010 and the second dies before 2013). Note: Portability does not apply to GST. For portability to apply to estates, the executor must make an election on the first-to-die’s estate tax return, even if a return would not have otherwise been required.

4. Alternative Minimum Tax (AMT) “patch” for 2010 and 2011.

• A two-year “patch” retroactive to the beginning of 2010 will keep the AMT exemption at or near 2009 levels through 2011.

5. Payroll tax reduction for 2011.

• Employees will receive a two percent reduction in Social Security taxes (on the first $106,800 of wages).
• This also applies to self-employed individuals.

6. Extension of IRA rollovers to charities.

• Taxpayers age 70½ or older will be allowed to make tax-free rollovers/distributions to charity from an Individual Retirement Account (IRA) of up to $100,000 per taxpayer per tax year in both 2010 and 2011.
• It is important to note that the taxpayer does not receive a corresponding income tax deduction for the charitable distribution, but likewise does not have to recognize the income from the distribution. In other words, the main income tax advantage of the rollover is the fact that the taxpayer’s adjusted gross income is not increased by the distribution.
• The distribution does count towards the taxpayer’s minimum distribution requirement.

7. 100 percent business write-offs from September 9, 2010.

• Businesses will be allowed to write-off 100 percent of qualifying equipment and machinery purchased and placed in service after September 8, 2010 and before January 1, 2012.

8. Short-term GRATs are still OK.

• Planners and taxpayers should be pleased to note that the Act does not include any grantor retained annuity trust (GRAT) provisions. While several outstanding proposals are calling for GRATs to have a minimum term of 10 years, short-term GRATs are still a viable estate freeze planning strategy for the time being.

2011 Planning Opportunities

Planning opportunities specific to 2011 as a result of passage of the Act include the following:1. Income tax planning.

• With federal tax rates on ordinary income, LTCG and qualified dividends remaining the same as the 2010 rates in 2011 and 2012, taxpayers return to most of the “normal” year-end tax planning; taxpayers may be able to lower their tax bills by:

1. Deferring income and/or accelerating deductions,
2. Accelerating long-term capital losses and/or postponing capital gains,
3. Converting a traditional IRA to a Roth IRA, and/or
4. Rolling an IRA over to a charity.

• Business owners may benefit from the 100 percent business write-off provisions within the Act by purchasing and placing qualified machinery and equipment into service in 2011.

• As the two-year extension period (2011-2012) proceeds, taxpayers with large tax exposures (e.g., future sale of a business, large concentrated stock positions, or nonqualified stock options) might consider having a plan to take income and gains off the table in advance of a potential tax rate increase in 2013.

• Taxpayers with qualified incentive stock options (ISOs) might consider exercising them in 2011. Doing so will start the holding period running and allow sales in 2012 at 15 percent LTCG rates in advance of the potential tax rate increase as of 2013, including the 3.8 percent Medicare tax.

2. Estate Tax Planning.

• For 2010 decedents, estate executors need to consider whether they want to elect out of the application of the new estate tax.

1. Generally, if the value of the estate is no more than $5 million (not taking any prior taxable gifts into account), it would be beneficial not to make the election since the estate would fall under the
2. $5 million exemption amount and, therefore, would not be subject to tax. Furthermore, the assets of the estate will be stepped-up to fair market value as of the date of death and future sales of inherited assets will be eligible for LTCG treatment.
3. If the value of the estate is greater than $5 million, it may be beneficial to elect out if the additional estate tax is less than the ultimate capital gains tax the heirs would pay if the assets did not receive a full step-up to fair market value.

• Even though the first to die spouse’s estate tax exemption is portable, married couples should still consider structuring their estate plans so that both spouses split their assets and make use of their full separate exemption upon their deaths. Using a properly structured bypass trust increases the likelihood that appreciation occurring after the first death is not taxed.

3. Gift and GST tax planning.

• Given that both the gift and GST exemptions increase to $5 million in 2011 and 2012, the Act creates additional opportunities to transfer assets to heirs starting in 2011. Taxpayers are encouraged to meet with their advisors to discuss how to take advantage of this potentially limited opportunity.

4. GRAT planning.

• Short-term GRATs should still be considered by taxpayers looking to freeze their estates in 2011. However, caution should be taken when implementing such trusts, given that there are still several pending bills containing the proposed restrictions on GRATs.

Since the information contained in this Wealth Management Update is general in nature, it may not pertain to your particular situation. Therefore, you should consult with your Wells Fargo advisor as well as your tax and/or legal professionals to determine if a particular strategy would be advantageous for you.

To summarize, here are the key estate, gift, and GST figures for 2009 through 2013:

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Prepared by Jenna L. Guenther, Financial Planner, Wells Fargo Wealth Planning Center. Scott A. Winget, Senior Director of Planning, Wells Fargo Wealth

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