Wealth Law Blog : Oregon Asset Protection Lawyers & Attorneys : Samuels Yoelin Kantor Seymour & Spinrad Law Firm : OR Estate Planning, Fiduciary Litigation

The clock is ticking! If Congress fails to act by the end of 2010, many significant tax provisions passed as part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (often informally referred to as “EGTRRA”) will simply expire. This “sunset” feature of EGRRRA was enacted so that the law would comply with the Byrd Rule, a rule that allows Senators to block a piece of legislation if it purports to significantly increase the federal deficit beyond a ten-year term. Now the ten-year clock has almost wound down. 

Here’s a summary of the significant changes to the tax code that will occur if Congress does not act:

 Tax Rates. Currently, the top tax rate is 35%. The following table is comparison of this year's tax brackets with an estimate of the 2011 post-EGTRRA tax rates, including a reinstated 39.6% tax rate: 

Capital Gains. If you are currently in the 25% or higher tax bracket, your maximum rate on capital gains is 15%. If you are in the 10% or 15% brackets, the maximum rate is 0%! After EGTRRA sunsets, the top capital gains rate increases to 20% (up to 10% for those below the 25% bracket).  

Qualified Dividends. Similar to capital gains, most corporate dividends are currently taxed at a 15% rate. These dividends are known as “qualified dividends.” After 2010, these dividends will be taxed in the same manner as ordinary income, up to the top 39.6% rate.

Phase-out of Itemized Deductions & Personal Exemptions. Prior to the Bush-era tax cuts, itemized deductions (including charitable donations, home mortgage interest, state and local income taxes, and property taxes) were reduced for higher-income individuals under a phase-out rule. Since 2006, this phase-out rule has, itself, been phased out so that by this year, itemized deductions were no longer subject to any limitations. However, in 2011, the phase out rule returns. Specifically, itemized deductions will be reduced by 3% of AGI in excess of the applicable phase-out threshold (approximately $170,000). The maximum reduction is limited to 80% of the affected deduction amounts. Similarly, certain EGTRRA limitations on the personal exemption phase-out rules will expire after 2010, thus further increasing the effective tax burden for high earners.

Estate Tax. At the time of EGTRRA’s enactment, the federal estate tax exemption amount was $675,000 and was scheduled to increase incrementally to $1,000,000 by 2006. EGTRRA increased the exemption amount to $1,000,000 in 2002, $1,500,000 in 2004, $2,000,000 in 2006, and $3,500,000 in 2009. In 2010, the estate tax (as well as the generation-skipping tax) is repealed. Between 2001 and 2009, the top estate tax rate dropped from 55% to 45%. If Congress does nothing prior to year’s end, the estate tax will be reinstated with a $1,000.000 exemption amount and a top rate of 55%.

Many are optimistic that Congress will act this year to make at least some changes to the tax code, particularly for those individuals with adjusted gross incomes of less than $250,000 and estates worth less than $3,500,000. However, in the wake of this year’s cantankerous debates in Congress over health care legislation as well as the election of Senator Scott Brown in Massachusetts (effectively sapping the Democrats filibuster-proof majority in the Senate), it may be difficult for Congress to find common ground over major tax legislation. The best bet for this may be changes in a “lame-duck” session following the fall elections. Stay tuned!

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In the coming months (possibly years), tax lawyers and accountants will be analyzing the ramifications to business of the new health care legislation which was recently signed into law by President Obama. One of the new provisions of this law marks the first time in history that the federal Medicare tax will be extended beyond wages and self-employment income to interest, dividends, capital gains, annuities, royalties and rents. This new tax applies to individuals with adjusted gross income above $200,000 and joint filers over $250,000.

For individuals above the $200,000/$250,000 thresholds, the tax will apply to all “net investment income”. In addition to all applicable income taxes, the new Medicare tax will be 3.8%. For regular wages, the new law also adds an additional 0.9% tax on wages over the threshold amounts (thus increasing the current tax on such wages from 1.45% to 2.35%).

One noteworthy aspect of this provision is that several types of income are excluded from the definition of “net investment income” and hence are not subject to the new tax. First, the tax does not apply to income from the operation of a trade or business. Therefore, the law appears to retain the current law’s exemption whereby the Medicare tax does not apply to S corporation distributions. 

The Medicare tax applies to income that is derived from rental income only if the landlord is a passive investor under the Tax Code’s current “passive activity” rules. Hence, if the landlord is a sole proprietor or an active investor in a partnership, LLC, or S corporation, the Medicare tax does not apply. Note, however, that if the landlord is a sole proprietor or an active investor in a partnership or LLC (but not an S corporation), income from the activity may be considered trade or business income that may already be subject to the Medicare self-employment tax, which the new law separately increases from 2.9% to 3.8% for high earners.

Capital gains are generally included in the new Medicare tax. However, gain from the sale of an interest in a partnership (including an interest in an LLC that is taxed as a partnership) or S corporation is subject to the new tax only to the extent that the gain is attributable to passive investment assets and not property held by the entity which is attributable to an active trade or business.

Finally, the Medicare tax does not apply to distributions from qualified retirement plans. This exclusion extends to distributions from employee profit-sharing and 401(k) plans, IRAs, Roth IRAs, and 403(b) plans from tax-exempt organization.

The new Medicare tax will become effective on January 1, 2013.

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  From time to time we will publish recent local cases or legislative bills:

In re Botimer, 166 Wash.2d 759, 214 P.3d 133 (2009).

Background:  Attorney disciplinary violations arose out of the relationship between Botimer and his clients:  a high school friend and the friend's mother. Botimer filed their tax returns, advised them regarding various family business pursuits, and negotiated a dispute over interests in one of the family businesses. The family was not advised there was a potential conflict of interest in representing multiple members of the family in these business deals, or the fact that their interests might better be represented by separate counsel.

Holding:  After discontent developed between the mother and the attorney, it all unraveled and the Washington Supreme Court upheld the six-month suspension of Botimer for three violations of the Rules of Professional Conduct.            

Instead of simply withdrawing representation, Botimer made two critical mistakes: (1) he sent a letter to the IRS detailing omissions and mis-statements Botimer believed the mother fraudulently gave to him to include on tax returns he prepared for her; and (2) Botimer assisted the high school friend's litigation counsel and provided the mother's tax returns and his substantiating documents and work product.  Not good choices. 

The Washington Supreme Court admonished Botimer for not obtaining his clients’ informed consent to represent all of them. An attorney may represent a family, but should make each member aware of the problems that could arise in the future because of the joint representation. 

Note for attorneys:  If you represent a family, you must explain the potential conflicts that may arise and obtain their informed consent to the joint representation and if things start to sour, the best choice of action is to withdraw from representation of all family members and not to reveal client confidences unless compelled to do so under a court order.

Note for those looking for attorneys:  Carefully weigh the cost savings of only one attorney against the possible problems joint representation may cause. 

For more on this case, see The Ethical Quandry.

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Lori Singleton-Clarke, a nurse from Maryland, accomplished two rare feats last month. She represented herself before the U.S. Tax Court and won. On January 11, 2010, a Wall Street Journal article featured Ms. Singleton-Clarke who successfully defended her $15,000 deduction for her M.B.A. school tuition.

After 24 years as a distinguished career as a nurse, Ms. Singleton-Clarke wanted to improve her health care risk management skills and earn a masters degree so that she would have greater credibility with highly educated doctors.  So she enrolled in an MBA Health Care Management program, and she successfully completed the program approximately three years later. 

The IRS audited her income tax return and disallowed the $15,000.00 deduction she had claimed for her tuition. After a number of conferences with the IRS and endless paperwork, the matter came before a tax court judge in November, 2008. 

• Ms. Singleton-Clarke did not have the money to hire a lawyer.
• She represented herself, a rather daunting task in the face of two IRS attorneys and IRS several assistants. 
• She held her ground, and carefully explained the time line of her career and her reasons for pursuing the MBA program.

The Tax Court finally issued its decision on December 2, 2009, and upheld the deduction of her educational expenses.  The court found that the MBA program was not a new trade or business for  Ms. Singleton-Clarke, but rather helped her improve her skills in her current employment of nursing.

Some of the key factors in the court’s decision were the facts that Ms. Singleton-Clark was already established in the nursing profession and the MBA was a general course of study the would not lead to a professional license or certification.

The deduction of educational expenses is always a challenge. In light of our current high unemployment economy, this is an important decision since it may encourage taxpayers learn how to prepare to substantiale deduction their education expenses in the pursuit of  additional education to maintain and improve their skills. 

[For a copy of the decision click here] Please note that the decision cannot be relied on by other taxpayers, but it does provide a good discussion of the regulations and applicable tax cases.

Congratulations Ms. Singleton-Clarke!

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From time to time we will publish recent cases and legislation: 

House Bill 3077 (pdf)

House Bill 3077 completely revamps the spousal elective share statute in Oregon. Oregon is one of several states to enact a more modern elective share statute which attempts to account for the increasingly prevailing use of trusts and other mechanisms that avoid probate and thereby limit the funds that a spouse can reach through an elective share statute. First, the statute sets out the “augmented estate” which includes probate and nonprobate assets of the decedent as well as the surviving spouse’s assets. Then, the spouse can elect to take a percentage of the augmented estate. The percentage the spouse can receive is based on how many years the couple was married, ranging from 5% for marriages under 2 years to 33% for marriages that continued for 15 years or more. The remainder of the Bill addresses procedural requirements for making an election as well as the effect such an election has on other gifts in the decedent’s will. 

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 Late in 2009, the IRS announced that the annual gift tax exclusion will remain unchanged in 2010 at $13,000. Under the Tax Code, this amount is adjusted based upon the Consumer Price Index. The annual gift tax exclusion amount was last changed at the beginning of 2009 when the amount increased from $12,000 to $13,000. 

If a gift is less than the exclusion amount, then (i) no gift tax will be due, (ii) no gift return must be filed, and (iii) the donor’s lifetime gift-tax exemption (currently $1 million) is not reduced. This is one of the few “free Bingo spots” in the Tax Code.

The gift tax exclusion amount applies on a per-donor, per-donee basis. This means that a married couple can make gifts to a single donee equal to $26,000. For example, a married couple with two children can make gifts totaling $52,000 per year. 

For cash gifts, the amount of the gift is equal to (not surprisingly) the amount of cash given. However, for gifts of property (both real property and personal property), the value of a gift for this purpose is based upon the fair market value of the property on the date the gift is made. Often, gifts of property have significant estate planning benefits (more on these issues in a later blog article).

I welcome your comments and questions!

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From time to time, we will publish blurbs on recent local court opinions and state legislation: 

Force v. Dep’t. of Rev., 2008 WL 5191844 (Or.Tax Magistrate Div.) (pdf)

Background: Decedent’s personal representative completed federal and state estate tax returns resulting in no tax owed on decedent’s farm. The state of Oregon issued a notice of deficiency for approximately $27,000. The personal representative argued that the state of Oregon, by statute, had to use the federal valuation method, which would result in $0 in state tax. 

Holding: The federal determination of federal estate tax is not binding upon the state in its separate and distinct calculation of the Oregon inheritance tax. Instead, the state tax imposed is appropriately determined based upon the formula contained in IRC section 2011(b)(1) (2000) as expressly adopted in ORS 118.010(2).

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One of the most surprising revelations that many of my clients experience is the fact that estate/inheritance taxes will be due upon their death, unless they do some planning.  These clients have been convinced that estate/inheritance taxes only affect the rich, and since they do not perceive themselves as rich, they have nothing to worry about.

What these clients don't realize, until our initial meeting, is what all is included in their taxable estate.  The asset most often left out is proceeds from life insurance.  If you have a million dollar life insurance policy, and you also have other assets, you will pay inheritance tax in Oregon, which has only a $1 million exclusion.

The second asset most often forgotten is retirement plans.  These amounts are not only included in your taxable estate, and therefore subject to the estate tax, but they are also, without proper planning, potentially subject to income taxes.

The third asset that people seem to forget when calculating their taxable estate is equity in their real property.  This one may seem more surprising than the others, but it happens quite frequently.

Fourth, there are assets that client's have received from their parent's estate planning, such as family limited partnership interests, that they tend to forget about.

For those who don't relish the idea of paying more taxes than is required (and I have yet to meet someone who does),  I recommend having a long discussion with your estate planning attorney about what is included, and what the estate tax exemptions are currently (see earlier posts about changes in the federal estate tax exemption).

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On September 21, 2009, the IRS announced a one-time extension of the special voluntary disclosure program to October 15, 2009.  Until this announcement the program was set to close on September 23, 2009.

Taxpayers who elect to participate in this program and disclose hidden accounts will have to pay taxes, interest and some penalties.  Taxpayers who don't participate are likelty to face harsher civil penalties and possible criminal prosecution.

Some taxpayers have accounts over which they have signature authority but no financial interest, or a financial interest in a foreign commingled fund.  The deadline for these taxpayers has been extended to June 30, 2010. 

There are two reporting requirements for each year that have to be met.  One is the amended federal income tax return and the other is Report of Foreign Bank and Financial Accounts (Form TD F 90-22.1) which must also be filed.  Unless all foreign bank accounts have a combined value of less than $10,000, this report is an annual requirement in addition to the federal income tax return.

If you have offshore accounts of any kind, you should take this opportunity to review your tax returns for 2003 through 2008 and any reports that you have filed to determine whether or not you are fully compliant. 

The IRS also announced that there would be no further extensions.

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Effective September 28, 2009, a new bill passed by the 2009 Oregon legislature imposes a new tax on what a legislative staff summary refers to as a “specified group of health insurers.” In particular, the new law assesses a 1% tax upon the gross amount of premiums earned by health insurance providers. The stated purpose of the new tax is to provide health insurance to low income children – a commendable objective.

As the popularity of insurance companies is probably not high, most people might not have a great deal of sympathy for the plight of the newly taxed. However, the tax has already begun to “trickle down” to the rest of us. I've recently read a copy of a letter from a CEO of a major Oregon health insurance provider to a customer. Noting the new tax’s impending effective date, the letter pleasantly informs the small business insurance customer that “your premium rates will be adjusted to reflect the new 1 percent tax.”

However, the “trickle” does not stop with the small business. The owner of that business will now need to make a difficult decision as to whether to raise prices, absorb the cost, cut costs of other employee benefits, or pass the additional costs on to employees. You get the idea – the tax lands upon small businesses and their employees at a time when many such businesses are stretched to the breaking point (assuming they’ve made it this far in the recession).

Is this really the intended consequence of the new policy? I welcome your comments and questions.
 

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At the risk of dating myself, I grew up watching Gilligan’s Island on television. As I did not grow up in a wealthy household, my youthful image of a “rich” person was Thurston J. Howell, III, the extremely wealthy and rather lazy member of the marooned “Gilligan” castaways. 

Demographic statistics (and my own anecdotal experience) tend to show that wealthy individuals in the United States do not resemble Thurston Howell. Rather, many are owners of small and entrepreneurial businesses. This conclusion has certainly been supported by the research of Dr. Thomas J. Stanley, co-author of the bestselling book The Millionaire Next Door. Dr. Stanley’s central finding is that wealthy individuals in America acquire their wealth through hard work, careful savings, and living a lifestyle well below their means. Often these individuals are “self-made” business owners whose hard work and good ideas have brought them economic success.

As I mentioned in my previous post, Congress is currently considering proposals to increase the top two tax brackets from their current 33% and 35% tax rates to 36% and 39.6%, respectively. Congressional leaders have proposed additional surtaxes that will be "layered" on top of the new higher tax rates.  Newly developed data from the Joint Committee on Taxation indicates that 55% of the tax from the higher rates will be borne by small business owners with income over $250,000. These same small businesses create 70% of all new private sector jobs in the United States.

I am neither an economist nor a politician. However, I am concerned that all too often, those seeking to soak ol’ Thurston Howell may really be hurting the owner of the corner store down the street, not to mention the employees that work at that store. Is that the intended consequence of the new tax policy?

I welcome your thoughts and comments!

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Recently, UBS announced that it had agreed to release the names of 4,450 of its account holders to the IRS. This is unsettling news for taxpayers with undisclosed foreign accounts. However, the IRS currently has a Voluntary Disclosure Program to encourage tax payers with unreported foreign accounts, unfiled tax returns, under reported income or frivolous tax deductions to participate and avoid further penalties and criminal prosecution. 

• Taxpayers must apply to the IRS before the IRS contacts the taxpayer. 
• On August 25, 2009, the IRS announced that UBS account holders would be eligible until the IRS received the information. Apparently, UBS is notifying its account holders before turning the names over. See IRS Voluntary Disclosure: Questions and Answers

This is crunch time!  UBS account holders are not the only taxpayers with unreported foreign accounts who should be concerned. The disclosure program is about to terminate. 

• Taxpayers have only until September 23, 2009 to participate in the program. 
• Voluntary disclosure will allow a taxpayer to avoid criminal prosecution and the assessment of significant IRS penalties. A taxpayer will still have to pay the income taxes, accrued interest and some penalties.  
• Taxpayers only have one opportunity to make a submission, and failure to qualify for the program, depending on the facts, may lead to criminal prosecution.

If you are interested in a confidential discussion with an attorney about this important opportunity, you may call us at 503-226-2966.

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In a few short months, after the Dog Days of summer have gone and the sweltering humidity of the Washington D.C. begins to subside, Congress will begin to get serious about finishing work on tax legislation that will make substantial changes to our current tax code. I’ll leave to the politicians to discuss the wisdom, or lack thereof, of these changes. However, one thing is certain – tax changes are on the way!

I have no crystal ball. However, as Congress debates health care legislation and begins to embrace the red ink from the fiscal stimulus legislation in the last year, significant changes to the Tax Code are as certain as January snow in Denver. For those whose time has come to pay their “fair share” of taxes, here are the ten changes that we’re most likely to see when the sun rises on New Year’s Day 2010:

1. Tax Rates. The “Greenbook” report released by the Obama Administration in May states that the current 33% and 35% tax rates will increase to 36% and 39.6%, respectively. These rates would affect those individuals with incomes exceeding $200,000 for single persons and $250,000 for married couples. While Congress still needs to make the final decision, the proponents of these increases tend to argue that these “reforms” merely represent a return to the Tax Code of the Clinton Administration.

2. Capital Gains. Currently, the maximum tax rate on recognized capital gains is 15%. Under current law, these changes expire after 2010, with the maximum rate scheduled to increase to 20%.  For the same group of high earners (singles making more than $200,000 and married couples making over $250,000), the 20% bracket would return early, most likely with the 2010 tax year.

3. Qualified Dividends. Certain “qualified” dividends received by individual taxpayers from corporations are currently taxed at a 15% maximum rate. Like the capital gains tax increase referenced above, the maximum tax on these “Q Dividends” would be increased to 20% as well. Interestingly, the Obama Administration did not advocate a return to the Clinton years when dividends were taxed in the same manner as ordinary income. My bottom line on this one – don’t count on it. An increasingly budget-conscience Congress will see it as “low hanging fruit.”  Look for the return of ordinary income tax rates on dividends.

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