IN THIS ISSUE: Federal Estate Tax Repeal? l Expanded Planning Opportunities for Roth IRAs l Out with the Old … In with the New l 2009 Deduction for Haitian Earthquake Relief Donation
By David M. Watts, Jr.
Effective January 1, 2010, there is no federal estate tax for decedents dying before January 1, 2011. It is likely, but not 100% guaranteed, that Congress will act to reinstate the federal estate tax during 2010. Meanwhile, the following points are noteworthy:
- If Congress does not act, the federal estate tax will be reinstated as of January 1, 2011, with a maximum rate of 55% and with a $1,000,000 estate tax exemption.
- While there is no federal estate tax, decedents are subject to a complicated carryover basis formula, with specific dollar amounts of basis step up to be allocated among a decedent’s assets.
- If the federal estate tax is reinstated this year, it is uncertain whether this can be retroactive to January 1, 2010 because of constitutional issues.
- There is still a gift tax during 2010, with the tax rate being 35%, a reduction from last year’s 45% rate. This may present an opportunity for some to make gifts to the next generations at a lower gift tax rate. However, if there is reinstatement in 2010, this may bring the rate back to 45%.
- It is possible that some formulas intended to optimally fund so-called “credit shelter” trusts may overfund such trusts to the detriment of the spousal trust for decedents dying during 2010 if the federal estate tax is not reinstated.
If you have a particular concern about your estate planning documents, you should consult your McNees estate planning attorney. As noted above, we believe that Congress will act during 2010 to clarify the current situation, but it is entirely possible that no action will be taken given the current congressional gridlock. Even aside from the current federal estate tax uncertainty, we recommend that you have your estate plan updated every five years or after significant changes occur in your personal situation.
By David M. Watts, Jr.
The Roth IRA is an alternative form of IRA which, if structured properly, allows for tax-free retirement income. The corollary, of course, is that contributions to a Roth IRA are not deductible, but the growth in the Roth IRA after the contribution to the Roth IRA is not subject to any federal income tax at all.
Before 2010, those with modified adjusted gross income of less than $100,000 could convert a traditional IRA into a Roth IRA, with the traditional IRA owner paying income tax on the amount in the converted IRA. This income restriction has now been lifted, and anyone can convert a traditional IRA into a Roth IRA. In addition, for conversions occurring during 2010, the income from the conversion is not reported in the year 2010; instead, half the income is reported in 2011 and the other half in 2012. Alternatively, the account owner can elect to pay the tax in 2010.
The big question in making this decision is what the tax rate situation will be after 2010. Unless Congress acts to change current law, after 2010 the income tax rates return to pre-2001 levels, with the top bracket being 39.6% instead of the current 35%. Thus, opting to pay the tax in 2010 may be the most advantageous way to minimize the income tax on the conversion.
The contribution limits for Roth IRAs remain in place. However, there are no contribution limits for contributions to traditional IRAs as long as there is sufficient earned income, although higher income taxpayers may not be able to deduct such contributions. Once the contribution has been made to the traditional IRA, it can then be converted to a Roth IRA in a subsequent year.
In order for the distributions from a Roth IRA to be tax free, the amounts in the account must be held in the account for at least five years. Distributions from the Roth IRA can then be made on a tax-free basis if made after age 59 1/2, after the owner’s death or disability, used to pay qualified first-time home buyer expenses, or are done in substantially equal periodic payments. Premature withdrawals are subject to a 10% penalty and the earnings subject to income tax.
It is possible to “undo” a traditional IRA to a Roth IRA conversion if done by October 15th of the year following the year of conversion. However, it is important to keep the converted funds separate from the regular Roth IRA funds until after the recharacterization period has passed.
Roth IRAs offer great planning opportunities, even for those who do not currently have a traditional IRA. However, the rules are somewhat intricate, so consult with your attorney or accountant before making decisions concerning your IRAs.
By Vance E. Antonacci
Along with the arrival of 2010 comes various income tax law changes that are highlighted below.
Individual Taxpayers
- The unpopular alternative minimum tax (the “AMT Tax”) still exists, but the exemption amount has been reduced. The AMT Tax exemption amount for 2009 was $46,700 for single filers, $70,950 for married taxpayers filing jointly or a qualifying widow or widower, and $35,475 for married taxpayers filing separately. For 2010, these exemption amounts have dropped to $33,750 for single filers, $45,000 for married taxpayers filing jointly or a qualifying widow or widower, and $22,500 for married taxpayers filing separately.
- Required minimum distributions had been waived for 2009 but are again required for 2010.
- The income limit on eligibility to convert a traditional IRA to a Roth IRA has been eliminated (see the related article in this newsletter for more detail).
- The phase-out of the personal exemption and of itemized deductions based on the taxpayer’s adjusted gross income is eliminated in 2010.
- With the repeal of the Federal Estate Tax, the rules for increasing the cost basis of assets passing from a decedent have changed (see the related article in this newsletter for more detail).
- Any taxpayer who claimed the first-time homebuyer credit must begin to repay that credit if the taxpayer disposes of the taxpayer’s residence before the end of the fifteen-year recapture period.
- The ability to claim either an itemized deduction or an increased standard deduction for state or local sales or excise taxes on the purchase of a new motor vehicle has expired.
- The tax deduction for qualified tuition and related expenses and the $250 tax deduction for education professionals for certain expenses have both expired.
- Taxpayers who are older than 70.5 years of age may no longer make a tax-free distribution from an IRA to a charity.
The reduced AMT Tax exemption amounts likely will have the greatest impact on taxpayers since the reduced exemption amounts greatly widen the net cast by the AMT Tax. Hopefully, Congress will pass another “patch” to increase the exemption amounts as it has done for the past few years. In general, tax deductions are popular and the expiration of the tax deductions outlined above and various other tax deductions that expired at the end of 2009 hopefully will be addressed by Congress as well. One significant benefit in 2010, though, is the elimination of the adjusted gross income phase-out of the personal exemption and itemized deductions. The elimination of the phase-out will benefit higher income taxpayers who in the past saw these benefits reduced or eliminated.
Business Taxpayers
- Employer-sponsored qualified retirement plans must now offer non-spouse beneficiaries the right to rollover an inherited plan account to an IRA. This option was permitted but not required in 2009.
- The deduction for domestic production activities increases for 2010. Taxpayers will be able to claim a deduction generally equal to 9% of the lesser of: (1) the taxpayer’s “qualified production activities income” for the tax year or (2) taxable income without regard to this deduction for the tax year. In prior years the percentage limitation was 6%.
- The deduction for additional first-year 50% bonus depreciation for qualified property has expired (but note that certain aircraft and long-production-period property continues to be eligible if placed in service in 2010).
- The maximum amount that may be expensed under section 179 is reduced to $134,000 (down from $250,000 for tax years beginning in 2008 or 2009).
- Various accelerated depreciation rules have expired (for example, the five-year depreciation period for farm business equipment and the fifteen-year, straight-line cost recovery for qualified leasehold improvements and retail improvements).
- Various enhanced charitable deductions have expired, including the enhanced deduction for the contribution of food and book inventories and for the contribution of computer equipment for educational purposes.
- Pursuant to the Worker, Homeownership, and Business Assistance Act of 2009, most businesses may now carry back net operating losses for three, four, or five years.
As with individual taxpayers, business taxpayers favor tax deductions. Arguably, the behavior of business taxpayers is influenced by the availability of tax deductions. For example, a business taxpayer may purchase less equipment because of the expiration of the 50% bonus depreciation or the reduced section 179 deduction. Conversely, a domestic manufacturer may increase domestic production activities due to the increase of the domestic production activities deduction.
Many of the tax benefits that expired for both individuals and businesses on December 31, 2009 were extended as part of the “Tax Extenders Act” passed by the House of Representatives in December, 2009. This Act, however, did not pass the Senate. Predicting how Congress will act is difficult, but practitioners (and clients) hope that Congress will pass legislation to address the expiration of the many popular tax breaks that expired on December 31, 2009.
President Obama recently signed into law legislation that allows taxpayers to get a 2009 income tax deduction for monetary gifts made to assist victims of the recent Haitian earthquake. The deduction is allowed for gifts to any charitable, section 501(c)(3) organization that commits to using the gift for Haitian earthquake relief.
In order to qualify for 2009 deductibility, the gift must be made before March 1, 2010. The cancelled check or gift receipt should make some reference to Haitian earthquake relief.
© 2010 McNees Wallace & Nurick LLC
McNees Insights is presented with the understanding that the publisher does not render specific legal, accounting or other professional service to the reader. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using this material must always research original sources of authority and update this information to ensure accuracy and applicability to specific legal matters. In no event will the authors, the reviewers or the publisher be liable for any damage, whether direct, indirect or consequential, claimed to result from the use of this material.