Two years ago, in 2010, there was a quirk in the Estate Tax laws. For one year, there was no estate tax because Congress did nothing that year. It was the first time there was no estate tax since the start of World War I in 1916. We were (in jest, to make a point) advising high net worth clients to, “hurry up and die”. In fact, George Steinbrenner and Glen Bell Jr. (founder of Taco Bell) died in 2010 costing the federal government billions in estate taxes when it could little afford it while waging two wars.
Now, two years later, with the Bush tax cuts looming to go away unless Congress acts, and with little or no change in the political makeup of Congress, the possibility that Congress does nothing between now and the end of the year is a strong reality. Will this country fall of the “fiscal cliff”? What will that mean to the average taxpayer and what can we do to plan for this possibility?
If Congress does nothing:
- Ordinary income tax rates will increase across the board from 10%, 15%, 25%, 28%, 33%, and 35% TO 15%, 28%, 31%, 36% with a top rate of 39.6%
- Capital Gains Rates will increase from 15%[1]TO 20% for taxpayers in the 28% bracket and above [2]and 10% for everyone else.
- Dividends will be taxed as ordinary income instead of net capital gains
- The Medicare Surtax of Obama Care will start at 3.8% of net investment income [3]
- Itemized deductions will be limited and high income taxpayers could lose up to 85% of their deductions.
- The Estate Tax exemption equivalency amount and gift tax exemption will go down from $5.12 million TO $1 million with rates moving up from a flat 35%, progressively, up to a maximum of 55%.
So what is our advice for high net worth clients?
- MAKE THAT “BIG GIFT” BEFORE YEAR END
- ACCELERATE INCOME RECOGNITION INTO 2012
- ACCELERATE GAINS FROM SALES OF CAPITAL ASSETS INTO 2012
- PUT OFF DEDUCTIONS INTO 2013 EXCEPT FOR BONUS DEPRECIATION
Even if Congress acts, you can anticipate that there will be heightened focus on the Estate Tax as a way to increase revenues without “raising taxes”. Congress can just do nothing and allow the exemption equivalency amount to revert back to $1 million. That would be consistent with the $60,000 exemption amount in 1957 based on the Consumer Price index [4] which has increased at a factor of 8 times since 1957. At $1 million, the exemption will have increased by a factor of 16.67 times, which even the current Congress should be able to justify.
If Congress does act by year end, you can expect a combination of some tax increases and revenue cuts, but given the election results, Obama will not have to go as far to the right as he did during his first term in attempting to reach a compromise. The “fiscal cliff” battle field has changed considerably which might help us see some positive results for this country before year-end, in any event, we recommend tax planning that recognizes that tax increases are inevitable, even if Congress does nothing.