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Financial Planning > Tax Planning

Battle Lines Drawn on Bush-Era Tax Cuts

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Senate floor action on taxes the week of July 23 lays out for the first time the battle lines on the future of the Bush tax cuts, especially estate tax policy going forward.

The bill, S. 3393, failed to garner the 60 votes needed to clear it for floor debate. It was introduced by Sen. Harry Reid, D-Nev., Senate majority leader, as a means of showcasing the Democratic approach to the coming battle over the future of the Bush-era tax cuts.

But it provided both parties the opportunity to display the ideological divide over tax policy they want the voters to rule on through the 2012 election.

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, if the estate tax provisions are allowed to expire, there will be a 60 percent drop in the exemption and a 20 percent gross increase in the tax rate.

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 $5.12 million for 2012.

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.

“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 Investment Advisors.

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 bring 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 server their clients,” according to a spokesman.

Separately, NAIFA president Robert Miller has urged Congress to resolve the tax issues before the end of the year. “Retroactive changes to tax laws put American families and businesses in a costly and paralyzing situation,” he said. “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.”

In the event that the tax hikes go through, Miller said, NAIFA members are “prepared for the worst” and will advise their clients on how to cope with the impact of potential tax hikes.

The purpose of the Reid bill is to stake out the Democratic position that they would only vote to extend current marginal income tax rates for individuals earning less than $200,000 a year; $250,000 for couples.

In a late move July 19, Senate Democrats signaled they will hold extension of the current, relatively generous estate tax provisions hostage to higher taxes on the wealthy.

They did so by removing language from a tax bill slated to hit the Senate floor next week that would restore estate tax policies to the same level as those in 2009.

The language removed from the bill, S. 3393, proposes to establish a $3.5 million per person exemption, indexed for inflation, and a 45 percent top rate.

As cleared for Senate action, the Reid bill also proposes to reinstate the personal exemption phaseout and overall limitation on itemized deductions that apply to high-income households.

The Republican bill, S. 3413, proposes to extend for one year the current estate tax levels of a 35 percent tax and a $5.12 million exemption.

Doug Siegler, a partner at Sutherland Asbill & Brennan in Washington and a member of Sutherland’s Tax Practice Group, believes the decision to remove the estate tax provisions from S. 3393 appeared to be part of a new Democratic Party strategy to play hardball on tax issues.

“Although no one can predict how the looming expiration of the so-called ‘Bush-era tax cuts’ will ultimately play out, the withdrawal by Reid of the estate and gift provisions from his middle class tax bill would seem to indicate that there will be a separate fight on the estate and gift tax,” Siegler said.

He explained that a number of Democrats felt “stung” by the concession, in 2010, that allowed an increase in the estate and gift exemptions to $5 million and a drop in the top tax rate of 35%, “and they may not be willing to make the same concession on these issues this time around.”

The bill as scheduled for floor action also proposes to establish the top rates for dividends and capital gains at 20 percent for 2013.

The bill would also extend the American Opportunity tax credit, the child tax credit, and the earned income tax credit for another year, as well as the Section 179 expensing provisions for businesses. It also would provide another one-year “patch” covering 2012 from the alternative minimum tax.

One provision of estate tax law will not be affected, Katzenstein said.

This 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 estate get the benefits of a couple’s exemption. The 2001 bill did not include such a provision.

However, 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.

Another casualty would be a provision sought by the insurance industry that extends 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.

Tax policy is critical to the life insurance industry.

Raising taxes on the wealthy and making estate tax policies less generous cuts two ways for the insurance industry.

First, it would provide greater incentive for more people to buy the tax-advantaged products that are the core of life insurance industry offerings, and for the wealthy to buy more tax-advantaged products than they do so currently.

For example, sales of variable annuities dropped precipitously after the Bush tax cuts went into effect in 2002. Ultimately, that forced insurers to provide return guarantees in order to compete in the marketplace. That hurt the industry’s balance sheets when the markets plunged in 2007 and especially 2008, severely impacting earnings and forcing some companies to buy above-market rates to raise more capital in a tight market.

At the same time, most agencies and brokerages are small businesses, organized as pass-through entities such as S-Corporations, Partnerships and Sole Proprietorships.

Thus, less-generous estate tax policies would raise the cost for families to structure their business to ensure that the families could retain the business when the current owner dies.

For example, Charles Symington, senior vice president of government affairs for the Independent Insurance Agents and Brokers of America, said allowing estate tax rates to revert to the Clinton-era levels would be “punitive” to agents and brokers, with a “a staggeringly negative effect on our membership.”

Symington explains that most agencies and brokerages are small businesses, organized as pass-through entities such as S-Corporations, Partnerships and Sole Proprietorships.

That means they pay taxes at individual rates, he said. In addition, many of our small business members are family-owned.

He said that allowing current estate tax law to expire would mean that in many cases a family business would have to be liquidated in order to pay the government.

“This translates to lost jobs in a time when our economy can least afford it,” Symington said.

He said that the IIABA is working with Congress to ensure an extension of current tax law is passed before the end of the year.

“It is the IIABA’s hope that this will set the table for a wholesale tax code overhaul next year,” Symington said.


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