Close Close

Financial Planning > Tax Planning

As Day of Reckoning Approaches, Professionals Prepare for "The Worst"

Your article was successfully shared with the contacts you provided.

Estate taxes paid by families and businesses and the planning that goes along with them will face a jarring impact if Congress is unable to bridge the ideological divide on taxes and tax cuts first enacted in 2001 and potentially expiring at the end of year.

Andrew Katzenstein, a partner in the Personal Planning Department with Proskauer in Los Angeles, said that if the so-called “Bush tax cuts” expire at the end of the year, income tax rates for the highest-earning individuals and families will rise from 36 to 39 percent, an eight percent increase.

But, by comparison to the tax rates, if the estate tax provisions are allowed to expire, there will be a 20 percent gross increase, and, from a percentage point of view, a 60 percent increase.

“When compared to the changes in rates that will occur, both the percentage of change and the gross percentage increase are dramatically more than virtually every other change,” Katzenstein said.

The inability of Congress to break an impasse on future tax policy deeply concerns the National Association of Insurance and Financial Advisors (NAIFA).

Approximately $600 billion in tax increases and government spending cuts are scheduled to automatically take effect at the beginning of 2013.

Many analysts have said this could yield serious consequences for the American public and could push the U.S. economy over the edge of what they have labeled a “fiscal cliff.”

“NAIFA is very concerned that congressional inaction will create a lot of uncertainty and make it difficult for advisors to do their jobs and serve their clients,” according to a spokesman.

And, NAIFA president Robert Miller urged Congress to “resolve the tax issues before the end of the year.”

He said, “Retroactive changes to tax laws put American families and businesses in a costly and paralyzing situation.”

He added that, “The uncertainties over rates, capital gains and dividends, the alternative minimum tax, estate tax rules, and other issues make effective financial planning difficult for everyone from individual families to large corporations.”

Still, he maintained that NAIFA members were prepared for the worst and advising their clients about how to deal with tax hikes.

Specifically, as amended in late 2010 for 2011 and 2012, the Bush tax cuts establish a $5 million exemption and a maximum 35 percent tax rate.

It also indexed the estate tax exemption starting this year, raising it to $5,120,000.

However, if the Bush tax cuts are allowed to expire, the estate tax will spring back to 2001 levels, with a $1 million personal exemption and a 55% top tax rate.

The estate and gift taxes will continue to be unified, as allowed under the late 2010 legislation that extended the Bush tax cuts through this year. Reunification was not allowed from 2001 to 2010.

One provision of estate tax law that will not be affected is the inflation adjustment for the annual gift tax exclusion. It will be $13,000 a year. This provision, which was formerly $10,000, has been adjusted for inflation and made permanent through a 1996 law.

However, another provision added in the 2010 extension will also expire. This provides for “portability,” that is eliminating the complex estate planning documentation necessary to ensure that beneficiaries of estates get the benefits of a couple’s exemption. The 2001 bill did not include such a provision.

Some employee benefits provisions sweetened through the 2001 law were made permanent through the 2006 Pension Modernization Act, according to William Sweetnam, a partner at the Groom law firm in Washington, D.C.

Sweetnam played a role in implementing the Bush tax cuts, or, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), while working in the Treasury Department in the early 2000s. 

These increased contributions to IRAs to $5,000; 401ks to $15,000, added a Roth 401k, and a provision allowing for catch up contributions for people over aged 50.

Other provisions of EGTRRA that will expire include a 2-year extension of the research-and-development tax credit and other tax incentives to support business expansion.

Yet another casualty would be a provision sought by the insurance industry that extends the deferral of taxes owned under so-called Subpart F. This will require insurance companies to pay taxes earned by foreign subsidiaries of U.S. companies even if that income was not repatriated to the U.S.

As for a transition, Katzenstein said that, taxpayers who think that the Bush tax cuts will be either allowed to expire, or if the estate tax provisions are extended through a compromise that reduces them, are busy making gifts in order to take advantage of the bigger exemption and the lower tax rate.