Tax

Changes to income taxes grabbed the lion’s share of the attention as the President and Congress squabbled over how to halt the country’s journey towards the “fiscal cliff.”  However, negotiations over exemptions and tax rates for estate taxes, gift taxes and generation-skipping taxes also occurred on Capitol Hill, albeit with less fanfare.

The primary fear was that Congress would fail to act and the estate tax exemption would revert back down to $1 million.  This did not happen.  The ultimate legislation that was enacted, American Taxpayer Relief Act of 2012, maintains the $5 million exemption for estate taxes, gift taxes and generation-skipping taxes.  The actual amount of the exemption in 2013 is $5.25 million, due to adjustments for inflation.

The other fear was that the top estate tax rate would revert to 55 percent from the 2012 rate of 35 percent.  The top tax rate did rise, but only 5 percent from 35 percent to 40 percent.

The American Taxpayer Relief Act of 2012 also makes permanent the portability provision of estate tax law.  Portability means that the unused portion of the first-to-die spouse’s estate tax exemption passes to the surviving spouse to be used in addition to the surviving spouse’s individual $5.25 million exemption.

Some Definitions and Additional Explanations

The federal estate tax is imposed when assets are transferred from a deceased individual to surviving heirs.  The federal estate tax does not apply to estates valued at less than $5.25 million.  It also does not apply to after-death transfers to a surviving spouse, as well as in a few other situations.  Many states also impose a separate estate tax.

The federal gift tax applies to any transfers of property from one individual to another for no return or for a return less than the full value of the property. The federal gift tax applies whether or not the giver intends the transfer to be a gift.  In 2013, the lifetime exemption amount is $5.25 million at a rate of 40 percent.  Gifts for tuition and for qualified medical expenses are exempt from the federal gift tax as are gifts under $14,000 per recipient per year.

The federal generation-skipping tax (GST) was created to ensure that multi-generational gifts and bequests do not escape federal taxation.  There are both direct and indirect generation-skipping transfers to which the GST may apply.  An example of a direct transfer is a grandmother bequeathing money to her granddaughter.  An example of an indirect transfer is a mother bequeathing a life estate for a house to her daughter, requiring that upon her death the house is to be transferred to the granddaughter.

When an entrepreneur begins a for-profit business, one of the key early questions he or she needs to answer is, “What kind of business structure will serve me best?” 

How should the business owner decide on the correct entity?

Making the final choice with regard to business entity usually involves weighing the answers to the following questions:

1. Which kind of entity allows me to operate most efficiently?
2. What entity choice will provide me maximum protection from the liabilities I am worried about?
3. Which choice is the smartest from a tax perspective?

Here is a quick overview of the most popular types of business entities, and how they stack up based on those three factors:

A Proprietorship, sometimes called a sole proprietorship, is simple to operate and its tax results are reported on the personal tax return.  Its owner is responsible for all debts of the business.

A Partnership involves more than one business owner.  While there are more hands available to do the work than a proprietorship, it is more complicated to operate because there need to be rules about how decisions are to be made and how finances are to be handled.  All the partners are liable for all the partnership debts.  The business’s tax results are reported on a separate tax return, but the results are passed through to the partners personally.

A Limited Liability Company (LLC) provides its owner(s) better liability protection than a proprietorship or partnership.  It also needs written rules about how it will be operated.  An LLC can have the tax characteristics of any one of the other entities listed here, depending on the choice the owner(s) make.

An S-Corporation offers the tried-and-true liability protection of a corporation with pass-through tax results similar to those offered by a partnership.  Corporations need a set of rules – called by-laws – on how it will operate.

A C-Corporation is a more traditional corporate structure, offering the same kind of liability protection as an S-Corporation.  It differs from most of the entities listed here, in that it has a separate tax identity from its owner(s).  In some cases, the separate tax entity offers certain kinds of tax management advantages.  Also, certain kinds of employee benefit plans create more favorable tax results in a C-Corporation.

If you are considering starting a business, you will need to get advice about your situation from an attorney and CPA.  If you do not already have an attorney, I will be glad to counsel you on the legal elements involved. 

If you are already operating a business entity, you should check with a CPA and an attorney to make sure your entity choice is still right for you.  Also, feel welcome to call on our office to make sure that you are taking full advantage of the tax breaks offered to owners of a business of your type.

A number of figures used in tax and retirement planning have been updated for 2011.  Most limits for pension and IRA contributions have been unchanged.  For example: 

1. The maximum contribution that can be made to a defined contribution plan in 2011 under Section 415 is the lesser of $49,000 or 100 percent of compensation—the same limit as in 2010. 
2. The limit on employee elective deferrals to Section 401k and Section 403b plans has remained at $16,500 in 2011.  The limit for Section 457 plan salary reductions has likewise kept steady at $16,500. 
3. The maximum elective deferral for a SIMPLE or 401k SIMPLE plan is $11,500 in 2011. 
4. The limit on IRA contributions remains at $5,000 for 2011.  Those 50 and older can still contribute an extra $1,000 under the special catch-up provision.

 Here are a few of the income tax changes: 

1. The standard deduction for joint filers and surviving spouses who do not itemize in 2011 is $11,600, up from $11,400 in 2010.  For heads of household, the deduction is $8,500, and for unmarried individuals it is $5,800.  The aged and the blind get an additional $1,150 or $1,450 added to their standard deductions, depending on their filing status. 
2. The personal exemption phase-out and itemized deductions phase-out have been eliminated for 2011 by the tax compromise passed late last year. 

And here are some other items that may be important to you: 

The social security tax rate for individuals has been reduced to 5.65% in 2011.  The rate for employers remains at 7.65%.  The rate for self-employed individuals has also been reduced—to 15.3%.  The taxable wage base for the OASDI portion is $106,800 in 2011.  Any additional compensation over that limit is subject to only the Medicare portion of 1.45%. 

These changes may affect your retirement plan, your income tax planning and your estate plan.  I recommend you take time to review those plans in light of the new numbers.  As always, please feel free to call us at (630) 443-8575 to discuss these or other financial security issues of concern.

Late in 2010 Congress passed temporary tax law changes which will be in force for the next two years.

Estate Tax

For 2011 and 2012 there is a $5 million exclusion amount for individuals.  This means a person can pass $5 million at death to anyone estate tax free.

• With proper estate tax planning married couples can pass up to $10 million estate tax free.
• The tax on amounts over the exclusion amount is 35%.
• There is also a portability feature to the $5 million exclusion amount for married couples.  It’s called the Deceased Spousal Unused Exclusion Amount (DSUEA).  It permits a married decedent’s unused portion of their exclusion amount to carry forward and be added to the surviving spouse’s $5 million exclusion amount.  This is available only from the estate of a spouse who dies in 2011 or 2012.  So for the survivor of a married couple their total exclusion amount would be $5 million plus the DSUEA.

Gift Tax

During 2011 and 2012 individuals can make total life time gifts up to $5 million.  Under the previous law the total amount was $1 million.  This considerable difference means a significant amount of assets can be transferred without gift tax over the next 2 years.

Generation Skipping Tax (GST)

The GST exclusion amount is the same as the estate tax exclusion amount of $5 million. 

There are significant tax planning opportunities stemming from the new tax legislation.  If you would like to discover how this new legislation applies to your estate contact us at (630) 443-8575.