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An Income, Estate and Gift Tax Newsletter for Professionalsfrom the Office of Gift Planning at Scripps Health Foundation
www.scrippsheritage.org
SPRING 2011
Scripps Heritage Planner
The Tax Relief Act of 2010:A Closer Look at the New Tax law
IN THIS ISSUE:
• Why Is the New Legislation Important?
• When Will It End? Regarding the Sunset Provision
• Income Tax Provisions that Affect Individuals
• Provisions that Affect Charitable Giving
• Transfer Tax Provisions
Our Services
The Office of Gift Planning at Scripps Health Foundation is available as a resourceto estate planning professionals. Our office will provide these services at no cost or obligation:
Immediate Telephone Consultations • Charitable Deduction CalculationsSummary of Benefits • Flow Charts and Graphs • Private Client Meetings
Presentations at Your Office • Seminars for Clients
Our Website: Resources for Estate Professionals
Please visit us online at www.scrippsheritage.org to find many helpful tools, calculators and linksto tax laws and articles. You may also sign up easily for our weekly eNewsletter on our web site.
Upcoming Gift Planning Luncheon Seminars
Outlook and Insights on the San Diego Economy
Wednesday, June 1, 2011
Yours, Mine, and Ours: Estate Planning and RemarriageWednesday, July 6, 2011
All presentations will take place from noon to 1:30 pmat the Founder’s Room, Schaetzel Center for Health Education
Scripps Memorial Hospital La Jolla9888 Genesee Avenue
La Jolla, CA 92037
See back cover for further information about these educational opportunities.
David E. WilliamsSenior Director of Gift Planning
Natalie GanzDirector of Gift Planning
“Through philanthropy, we help to heal, enhance and save lives.”
T E STA M E N TA RY T R U STS A N D C H A R I TA B L E G I V I N G
Introduction:Why Is the New Law Important?The Tax Relief, Unemployment InsuranceReauthorization, and Job Creation Act of 2010(TRUIRJCA) has a wide-ranging impact on indi-vidual and corporate taxpayers. Among theaspects of the new law are general changes thataffected individuals, the extension of several pro-visions that encourage charitable giving, andwholesale changes to the estate, gift and genera-tion skipping transfer tax laws.
This booklet discusses the new law and itsimpact. Note that this summary of TRUIRJCAis not exhaustive. In particular, provisions con-cerning energy and business are not covered.Other provisions that affect individuals havebeen omitted.
When Will It End?Regarding the Sunset ProvisionA sunset provision is a part of an enacted lawthat effectively returns the tax code to a state thatwould exist as if the law had never been passed.Sunset provisions have been included in a tax lawwhen Congress utilizes a procedure called “recon-ciliation.” The Congressional Budget Act of 1974established the reconciliation process as a way toensure that certain laws will conform to tax andspending levels set in a budget resolution. Thus,changes recommended by committees pursuant toa reconciliation instruction are incorporated intothe reconciliation measure. The sunset provisionensures that the proposed law will satisfy the taxand spending levels as described by the budgetresolution.
The Economic Growth and Tax Relief Reconcil-iation Act of 2001 (EGTRRA) contained a sunsetprovision; as written, certain provisions of andamendments made by EGTRRA would not applyafter December 31, 2010. Also, the Jobs andGrowth Tax Relief Reconciliation Act of 2003(JGTRRA) contained a similar sunset provision.Thus, the date of December 31, 2010 held enor-mous importance.
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In anticipation of the great changes in tax policythat would arrive at the end of 2010,Congressional leaders (with President Obama’sassent) crafted a law that would effectively holdmany parts of the EGTRRA and JGTRRA inplace for one or two additional years—in effect,TRUIRJCA simply moved back the effective dateof the sunset provision to December 31, 2012.
Plus, TRUIRJCA included many so-called “taxextenders”—one or two year temporary measuresthat Congress has passed in successive years. Anexample of a tax extender is the AMT exemptionpatch. The AMT exemption amount is set bystatute, and is not indexed to inflation. In orderto avoid a greater number of people becomingexposed to the parallel tax system of the AMT,Congress has increased the exemption amount ona yearly basis. Such tax extender bills are expedi-ent to enact and offer a short term fix to a prob-lem, but do not permanently change the tax code.Like the EGTRRA and JGTRRA provisions, thesetax extenders are temporary.
Tracking Expiring Federal Tax ProvisionsEvery year, the Joint Committee on Taxation pub-lishes a list of expiring federal tax provisions overthe next ten years. Whether the provision willexpire completely or simply revert to the law ineffect before the present-law version of the provi-sion, the publication lists the code section andexpiration date.
One can access the list through www.jct.gov. Thecurrent list was published on January 21, 2011 asJCX-2-11.
Income Tax Provisions that AffectIndividualsIncome Tax Rates Preserved The change in income tax rates introduced byEGTRRA—the reduction in the five basic rates to15%, 25%, 28%, 33% and 35% and the addi-tion of the lowest income tax bracket of 10%—was extended through 2012. Originally, underEGTRRA, the rates were to be gradually loweredover several years. However, JGTRRA made the
THE TAX RELIEF ACT OF 2010: A Closer Look at the New Law
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low rates effective on January 1, 2003. Under thesunset provisions of the Bush-era legislation, afterDecember 31, 2010 these rates would have revert-ed back to the higher rates in effect prior toEGTRRA. However, TRUIRJCA preserves theBush-era tax rates for 2011 and 2012. Also, therange of income defined by each tax bracketremains indexed to inflation.
Marriage Penalty Avoided The relief from the “marriage penalty” affordedby EGTRRA continues under TRUIRJCA. Theprovisions that double the standard deduction fora married couple filing jointly and widen the 15%tax bracket for these filers (in an amount doublethe size of the corresponding rate bracket for asingle person) will stay in effect for 2011 and2012. Otherwise, the tax imposed on a marriedcouple could be greater than the tax owed if hus-band and wife had filed separately.
Capital Gains and Dividend Rates IntactThe capital gain and qualified dividend tax ratesintroduced by JGTRRA—15% and 0%—wereextended through 2012. Under JGTRRA, the taxrate for capital gains on property held for morethan one year was reduced from 20% to 15%.And for taxpayers with a top marginal tax rate of10% or 15% the rate was further reduced to 0%.The same Bush-era legislation that reduced capitalgains taxes also lowered the rate on qualified div-idends. Instead of being taxed as ordinaryincome, qualified dividends are taxed at 15% or0%, depending on the individual’s top marginaltax rate (same as for capital gains).
Suspension of the Pease Limitation and PEP In past years, an overall limit on itemized deduc-tions for high income taxpayers (known as the“Pease” limitation) would reduce what a taxpayercould deduct by 3% of adjusted gross income fordeductions in excess of a certain dollar amount(not to be reduced more than 80%). EGTRRAincrementally rolled back the Pease limitation onitemized deductions:
• A one-third reduction of the limitation in 2006and 2007
• A two-thirds reduction in 2008 and 2009 • No limit at all in 2010
TRUIRJCA extends the effective repeal of thePease limitation for 2011 and 2012.
Similarly, the personal exemptions claimed byhigh income taxpayers once had to be reduced by2% for each $2,500 in adjusted gross income inexcess of a certain dollar amount. EGTRRA alsoincrementally rolled back the personal exemptionphase-out (PEP) for high income taxpayers untilthere was no reduction at all in 2010. TRUIRJCAextends the repeal of the personal exemptionphase-out in 2011 and 2012.
Payroll Tax HolidayAn especially popular provision with wage earn-ers is the payroll tax holiday. Employers arerequired to withhold a certain percentage ofwages on every paycheck for social security. Boththe employee and the employer are normallyrequired to contribute 6.2% of wages towardsthis obligation (a total of 12.4%). However, in2011 the employee’s contribution is reduced 2%so only 4.2% of the employee’s wages arerequired to satisfy the payroll tax. Note that themaximum amount of annual wages subject to thepayroll tax is $106,800. A person earning thisamount (or more) will have an additional $2,136in take-home pay.
AMT Exemption Congress has put into place an AlternativeMinimum Tax (AMT) exemption “patch” for2010 and 2011. This temporary measure will pre-vent the AMT from applying to a greater numberof taxpayers (due to a low statutory exemptionamount). The exemption amounts for 2010 and2011 are as follows:
Filing Status 2010 2011
Married Filing Joint Return (or Surviving Spouses) $72,450 $74,450Married FilingSeparate Returns $36,225 $37,225
Unmarried Individuals $47,450 $48,450
Tax DeductionsCertain tax deductions that benefit individualswere extended by TRUIRJCA, including:
• The Option to Deduct State and Local SalesTax
• Tuition Expenses – An “above the line”deduction
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• Student Loan Interest – Both an increasedadjusted gross income limit before phase-out ofthe deduction and an extension of theavailability beyond sixty months after loanpayments begin
Tax CreditsMany popular tax credits that benefit individualswere extended by TRUIRJCA, including:
• Child Tax Credit – An increase in the credit to$1,000
• American Opportunity Tax Credit – Anenhanced version of the Hope Credit thatcredits 100% of the first $2,000 of tuitionexpenses, and 25% of the next $2,000
• Adoption Credit – An increase in the credit to$10,000
• Dependent Care Tax Credit – An increase in theamount of eligible expenses and the applicablepercentage for the credit
Provisions that Affect CharitableGivingIRA Charitable RolloverThe new law revives the IRA Charitable Rolloverthat permits donors age 70 1⁄2 and over to makea qualified charitable distribution directly from anIRA to a charity in 2010 and 2011. The distribu-tion is not taxable income for donors, and theamount counts towards the required minimumdistribution for that tax year.
There are certain rules that apply to a qualifiedcharitable distribution from an IRA, including:
• The charity must be a public charity or privatefoundation that may receive generalcontributions (except not a Donor AdvisedFund, nor a Sec. 509(a) SupportingOrganization)
• The distribution must otherwise qualify as acharitable income tax deduction
• An individual may direct up to $100,000 peryear in this manner
• The distribution does not qualify for acharitable deduction
Note that donors who completed an IRACharitable Rollover before January 31, 2011 havean option: to elect to treat the distribution asmade in either 2010 or 2011.
Extension of the Increased Deduction Limits forContributions of Real Property Made forConservation PurposesThere are annual limits on how much of a chari-table contribution can be deducted under IRCSec. 170. The standard limit on the deduction oflong-term capital gain property to a qualifiedpublic charity is 30% of adjusted gross income(AGI). However, a charitable gift of real propertymade for conservation purposes can be deductedup to 50% of AGI for a limited time. Furthermore,the carryover of the excess contribution amountof this gift into future years is increased from fiveto fifteen years.
In order for the gift to qualify, the property mustbe subject to a perpetual easement or restrictivecovenant that prevents the development of theproperty, safeguarding its natural character or his-toric significance. There are even more beneficialrules for farmers and ranchers who make such agift if the contribution does not prevent the use ofthe donated land for farming or ranching purpos-es. The enhanced deduction for contributions ofreal property made for conservation purposes isextended through the end of 2011.
Extension of the Enhanced Deduction forContributions of Certain Inventory Inventory is considered ordinary income propertyfor purposes of determining the deduction for acharitable contribution. Under normal rules, thededuction for a gift of ordinary income propertyis reduced by whatever would be considered gain(which usually leaves the deduction at cost basis).However, there are exceptions: gifts of foodinventory (made by corporate or non-corporatetaxpayers), book inventory and computer invento-ry (made by corporations) will only be reduced byone-half of what would be gain if it had beensold, or up to twice the donor’s cost basis(whichever amount is less). The enhanced deduc-tion for contributions of certain inventory isextended through the end of 2011.
Favorable Basis Adjustment to Stock of SCorporations Making Charitable Contributionsof PropertyBefore the passage of the Pension Protection Actof 2006, if an S corporation made a gift to a qual-ified charity, each shareholder would account forhis or her pro rata share of the contribution
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date). However, the revived estate tax under TRU-IRJCA is also subject to its sunset provision,which means a return to a $1 million applicableexclusion amount and a top rate of 55% in 2013if Congress takes no action.
Portability of the Deceased Spousal UnusedExclusion AmountIn the event the decedent dies in 2011 or 2012,the decedent’s estate may use some, all or none ofthe applicable exclusion amount. If the decedent’sestate uses only some or none of the applicableexclusion amount, the executor can elect to trans-fer the unused applicable exclusion amount to thesurviving spouse. Thus, the estate of the survivingspouse has his or her individual applicable exclu-sion amount plus what was left by the first spouseto die.
Portability and the Relevance of Bypass TrustsFor years, married couples have utilized bypasstrusts as a way to make full use of the availableestate tax exemption. At the death of the firstspouse, the will divides the estate into two parts.One part, equal to the applicable exclusionamount, is placed in a trust that provides liberalbenefits to the surviving spouse, but bypasses hisor her estate at death. The other part either passesoutright to the surviving spouse or is placed in amarital trust for the spouse’s benefit.
Many commentators have noted that some mar-ried couples may be less inclined to use the bypasstrust in 2011 and 2012 because of the availabilityof the deceased spousal unused exclusion amount.At first glance, it would seem the applicableexclusion amount not used by a spouse who diesin 2011 or 2012 would not be wasted—any partof the applicable exclusion amount not usedwould eventually be available to the estate of thesurviving spouse, so none of the exemption is lostas a result of not planning with a bypass trust.
However, a bypass trust may still be useful forseveral reasons:
• The deceased spousal unused exclusion amounttransferred at the time of the first spouse’sdeath may not suffice to protect assets in thesurviving spouse’s estate which continue togrow.
• The portability of a spouse’s unused exclusionamount may not apply to state estate taxes
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when determining income tax liability. To wit, ashareholder would reduce his or her basis in thestock by the amount of the charitable contribu-tion that flows through to the shareholder.
However, after the PPA and subsequent legisla-tion, the amount of a shareholder’s basis in S cor-poration stock reduced by reason of a charitablecontribution made by the corporation is limitedto the shareholder’s pro rata share of the adjustedbasis of the contributed property, not its fair mar-ket value. This benefit to S corporation share-holders is extended through 2011.
Transfer Tax ProvisionsOption to Subject 2010 Estate to Taxation Due to the sunset provision of the EGTRRA,there was no Federal estate tax in 2010. However,modified carryover basis rules applied to theestate property. This meant the decedent’s incometax basis is the starting point for determiningbasis for the heir who receives the property. Theexecutor could allocate $1.3 million towards thebasis for all heirs and an additional $3 milliontowards property to the spouse.
Under the new law, however, the executor of anestate of someone who died in 2010 has anotheroption besides the no estate tax/modified carry-over basis regime: choose to subject the estate totaxation under the 2011 rates and applicableexclusion amount (tax rate of 35% and a $5 mil-lion applicable exclusion amount). The executormust weigh the advantage of subjecting the estateto the tax in order to utilize the stepped-up basisrules (the fair market value at the time of deathdetermines basis which is to the advantage of theheir who receives the property).
The Revived Estate TaxThe federal estate tax has returned. The estate taxapplicable exclusion amount equals $5 millionand the top tax rate is 35% in 2011. For yearsafter 2011, the applicable exclusion amount isindexed for inflation and can increase in incre-ments of $10,000. The stepped-up basis is part ofthe revived federal estate tax. Assets acquiredthrough the estate receive a basis of the value ofthe asset on the date of death (or the value of theasset up to six months following the date of deathif the executor chooses the alternate valuation
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because many states have effectively de-coupledtheir own estate tax from the current federalestate tax law.
• A bypass trust can provide protection fromcreditors of the surviving spouse.
• Assets in the bypass trust eventually go toindividuals the deceased spouse names in his orher trust as beneficiaries.
• The deceased spousal unused exclusion amountdoes not apply to generation-skipping transfertax.
• The portability provision is temporary. Thefederal estate tax in 2013 may or may notinclude portability depending how Congressdoes or does not act.
Restoration of the Unified Credit Prior to EGTRRA, there was a unified credit—thelifetime exclusion for gifts was the same amountas the estate tax applicable exclusion. EGTRRAde-coupled the credit amount—the lifetime gifttax exclusion was restricted to $1 million and theestate tax applicable exclusion amount graduallyincreased to $3.5 million. The new law re-linksthe gift and estate tax applicable exclusionamounts for 2011 and 2012.
The Gift Tax The tax rate for the gift tax is 35% (like theestate tax). As noted above, the lifetime applica-ble exclusion amount for taxable gifts is $5 mil-lion in 2011 and 2012.
The Generation Skipping Transfer Tax Due to the sunset provision of EGTRRA, therewas no generation skipping transfer (GST) tax in2010. However, the new law replaces the no GSTtax regime in 2010 with a 0% GST tax rate and a$5 million exemption (so no GST tax applies to2010 transfers).
The GST tax in 2011 and 2012 correspondswith the $5 million applicable exclusion amountand a tax rate of 35%.
In ClosingGiven the short-term nature of TRUIRJCA, onesalient characteristic of the new tax law is itsimpermanence. The same difficult tax policyquestions Congress faced in late 2010 will remain
up for debate in 2011 and 2012. Many commen-tators on Federal tax laws have noted the difficul-ty posed by this uncertainty. For instance, estateplanning becomes more complex when consider-ing the possibility the law could drasticallychange in two years (and complexity costs timeand money).
As ever, tax professionals must be wary of theneed to maintain flexibility in estate planning sothat a change in the law does not have adverseeffects. Also, informing clients of anticipatedchanges in the law gives them the opportunity toact right away before the law changes or waituntil it turns to their advantage.
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Upcoming Gift Planning Luncheon SeminarsComplimentary lunch and validated self-parking are provided — MCLE credit is offered and available for those who qualify.
Reservation details & location are listed below
Please visit us online at www.scrippsheritage.org where you will find many helpful tools and links to tax laws and articles.If you are not already receiving our weekly eNewsletter, you may sign up easily on our web site.
David E. WilliamsSenior Director of Gift Planning
Yours, Mine, and Ours: Estate Planning and RemarriageWednesday, July 6, 2011, noon to 1:30 pm
Presented by: Jacqueline Parks,
Senior Vice President,Wealth Strategist, US Trust
Frann Setzer, Senior AssociateAttorney, Fleischer & Associates
What are the key planning issues to consider when preparing for remarriage, andhow can you help your clients in this process? Upon the death of a spouse, whatactions should be taken for a smooth road when settling their estates later? Ourspeakers will review community property and separate property law, inheritancelaw, premarital agreements, and other ways that an “ounce of prevention” can giveyour clients the best chances for success.
By Reservation Only – Deadline: July 1, 2011
Outlook and Insights on the San Diego EconomyWednesday, June 1, 2011, noon to 1:30 pm
Presented by: Alan Gin, Ph.D.,
Associate Professor of Economics,University of San Diego
From around the globe to around town, how have recent events impacted the SanDiego economy? What might we expect to see on the horizon? Our speaker willdiscuss his insights on the local economy and the Index of Leading EconomicIndicators for San Diego County. He will also present his perspective on the currentlocal housing and labor economies as well as his outlook for the future.
By Reservation Only – Deadline: May 27, 2011
Save the Date!
We invite you to join us on the following dates for educational luncheons this fall:Wednesday, September 7, 2011, noon to 1:30 pmWednesday, October 5, 2011, noon to 1:30 pmWednesday, November 2, 2011, noon to 1:30 pm
Updated information on speakers and topics will be posted to the Office of GiftPlanning website, www.scrippsheritage.org, as it becomes available.
PLEASE NOTE: All presentations will take place at:
Founder’s Room, Schaetzel Center for Health EducationScripps Memorial Hospital La Jolla
9888 Genesee AvenueLa Jolla, CA 92037
To make a reservation: email [email protected] or call 858-678-7120
Natalie GanzDirector of Gift Planning