A) Federal Estate Taxes:
The big news is that for the 2010 tax year, there are no estate taxes; well that is unless the law is repealed and made retroactive. This is a repeal with a one year term limit. Estate taxes are only applicable for “wealthy” estates. Certain members of Congress have politicized the tax by branding it as a “death” tax, and encouraging a large percentage of the population for whom estate taxes have no relevance to fight the battle for permanent repeal. In reality, by and large, only one to two percent of the entire American population is subject to these taxes, yet clever marketers have incited people of average means to join the tea party. The amount of an estate that can be left to beneficiaries exempt from federal estate taxes has been increasing since the enactment of the 2001Tax Act. In fact, the exemption has escalated from $ 1 million in 2001 to $ 3.5 million in 2009. The Byrd Rule is legislation which limits the duration of laws with a negative fiscal impact to ten years. It was anticipated back in 2001 that Congress would re-enact the terms of the estate tax law prior to 2009 and disqualify the one year suspension of any federal estate tax. However, that never happened. Therefore, under present law, there is no tax in 2010; however, due to the Byrd Rule, the tax reappears in 2011 back to the 2001 level of $ 1 million.
At first blush, as a beneficiary, it would appear that 2010 might be a really good year for your loved one to pass away, speaking only fiscally of course. However, there were other parts of the 2001 Tax Act that have not been sufficiently publicized or politicized, and these provisions will in reality negatively impact far more estates than the estate tax would have.
The provision in the law about which I refer relates to what is commonly known as a “step-up” in cost basis. The step-up allows beneficiaries to value the assets that they inherit based on the market value at the date of the donor’s death. Here’s the kicker. Although the estate tax has been eliminated for 2010, the step-up in cost basis has been significantly altered to the detriment of taxpayers. Under present law, the estate of a decedent who dies in 2010 can allocate a maximum of $1.3 million as an aggregate step-up. Beyond that, the beneficiary will step into the “shoes” of the decedent and receive his/her cost basis in the assets. Therefore, when the beneficiary in turn sells those inherited assets, he/she will pay tax on the gains over and above what the donor paid originally for the asset, over the $ 1.3 exemption. If the asset happens to be property that the donor owned for a great number of years, the gains could very well be very substantial. Assets left outright to a spouse receive an additional $3 million “spousal property basis increase”.
Unless the law is modified, 2010 may very well turn out to be a windfall year for a super-wealthy person to die, from solely a tax perspective. However, it may be a disaster for a middle class estate. The following example will elucidate the dilemma. Let’s say two widows at the date of death each owned the same numbers of shares of stock purchased on the same day. And, let’s say the cost basis of that stock was $10,000, and that the market value at the date of death was $100,000. Let’s also assume that the wealthy widow’s estate was valued at $20 million and that the middle class widow ‘s estate was valued at $1 million. In this example, the wealthy widow gets a big advantage in 2010 because she will incur no federal estate tax, which in 2009 and other prior years would have resulted in roughly $50,000 in estate tax. Her beneficiary will have to pay capital gains tax on the $90,000 gain resulting from the sale of the stock. With the capital gains tax rate of 15% through 2010, the beneficiary will incur a capital gains tax of approximately $13,500, approximately $36,500 better than had the estate been subject to federal estate taxes. In contrast, the middle class widow in 2009 would still have fallen within the federal estate tax exemption, and hence had a zero estate tax. In 2009 and prior years, her beneficiaries would have received the step-up in cost basis for the stock and therefore, they would have incurred zero capital gains taxes. In reality, in 2010, the beneficiaries of the wealthy and the middle class widows incur identical capital gains taxes on the gains from the stock sale. Consequently, the middle class heirs owe the $13,500 in capital gains taxes, thereby reducing their net inheritance by this amount. The bottom line is that the super-wealthy may turn out to be the big winners in 2010, and the middle class may be incurring even greater proportions of the tax burden in the U.S.
B) Other Significant Tax Changes:
1) The maximum amount of equipment placed in service that a business can expense as a deduction is cut by nearly 50% from $250,000 to $135,000.
2) Taxpayers age 70.5 and older can no longer make a charitable contribution directly from their IRA’s, and thereby avoid income taxation on the amount donated. This could have a huge negative impact on a non-profit’s budget.
3) 2010 represents the last year during which capital gains will be taxed at the rate of 15% and 0% for taxpayers in the 10% and 15% tax brackets. Next year, the rate goes to 20% for most taxpayers and 10% for taxpayers in the lower brackets. However, gains on assets held for five years or longer, beginning in 2011 will be taxed at 18% and 8% respectively.
4) For taxpayers in tax brackets of 15% or higher, 2010 represents the last year in which dividends will be taxed like capital gains at a significantly reduced rate of 15%. After 2010, dividends will be taxed at the highest earned income rate. Ouch.
C) Important Take-Aways:
1) It is important to appreciate that there is no federal estate tax in 2010; however, significant gift taxes which affect the majority of taxpayers remain, making it equally as expensive to gift in 2010 as it was in 2009. A donor can gift up to $1 million as a lifetime exemption as well as $13,000 per year as an annual gift exclusion amount, but gifts in excess of these exemptions remain taxable transactions.
2) The estate tax in Maryland remains unaffected by changes to the federal system. As such, estates whose values exceed $1 million are still subject to Maryland estate taxes.
3) Because the federal estate tax exemptions have been changing regularly over the last several years, it is common language in wills and trusts to leave assets to non-spouse beneficiaries up to the federal exemption amount with the residual to go to the spouse. As an unintended consequence of your estate planning documents, your estate plan may leave everything to children or other relatives, unintentionally disinheriting your spouse.
Clearly 2010 is a year of significant tax and estate planning review. Feel free to contact me regarding any specific situation where you have concern or just seek clarity. We are also well suited to recommend accountants and estate planning attorneys who specialize in these areas. In law school, I remember references in several business and tax classes to a famous United States judge and judicial philosopher by the name of Learned Hand. Judge Hand professed, “Anyone may arrange his affairs so that his taxes shall be as low as possible. And, there is not even a patriot duty to increase one’s taxes. Nobody owes any public duty to pay more than the law demands”. In a year where we will all be affected by rising tax rates, it is important to heed the advice of Judge Hand and plan accordingly.
Sincerely,
Greg Gann
Please talk to your financial advisor and tax advisor for advice on your specific situation prior to executing any strategy as individual situations may vary.
Wednesday, February 17, 2010
Monday, January 25, 2010
Important Tax Changes for 2010.....written by Greg Gann
There are two very important tax differences which distinguish Roth IRA’s from traditional IRA’s. The first is that distributions taken from a Roth are not taxed, provided the Roth has been funded for a minimum of five years and the distributions commence after the recipient reaches age 59.5. The second benefit is that a Roth does not require taking minimum distributions beginning at age 70.5 as do traditional IRA’s. They also can be left for a beneficiary without the beneficiary having to deplete from her inheritance the applicable income taxes, as would be the case for a beneficiary who is left a traditional IRA. A Roth allows annual contribution amounts of up to $5000 or $6000 for folks age fifty and over provided adjusted gross income falls between $105,000- $120,000 for single filers and $167,000-$177,000 for joint filers. Prior to January 1, 2010, in order to convert a traditional IRA into a Roth, adjusted gross income could not exceed $100,000.
Today, however, there are no income limitations as to who is and who is not eligible to convert. In addition, there was an added change provided by the IRS, which only exists for the 2010 tax year. The change is that the IRS has granted the option to claim 50% of the conversion amount as income in 2011 and the remaining half in 2012. If one elects to defer and pay the tax over the two year period, he or she will pay the tax based on his or her tax bracket for that year. This could be more costly and therefore less advantageous if say the taxpayer expected a bonus or other qualifying event that would make 2012 a higher tax year. Because money in a traditional IRA has never been taxed, any distribution from a traditional IRA is considered income in the year in which it is received. Converting from a traditional IRA to a Roth IRA is considered a distribution, and therefore can substantially impact income taxes due in the year of conversion. It can even throw a taxpayer into a much higher tax bracket. This part of a conversion for tax purposes is very clear. Where it gets a little more complicated is for those tax payers who maxed out on deductible retirement plan contributions, but nonetheless funded a traditional IRA with after-tax contributions in order for the proceeds to grow tax deferred.
Unfortunately, we are not permitted to segregate the pre and post-tax contributions thereby allowing the post-tax contributions exclusively to be withdrawn to avoid income taxation when making a conversion, and a specific three step formula must be followed. Step one is to divide the total after tax contribution by the total IRA account balance to come up with a non-taxable percentage. Step two requires multiplying that percentage by the total amount that is desired to be converted. The quotient reached in step two is subtracted in step three from the total amount desired to be converted.
Example: Let’s say we contributed total after-tax contributions to a traditional IRA over the years of $50,000. And, let’s also establish that the total value of the traditional IRA, (including both pre and post tax contributions totals $300,000). And let’s say that we desire to convert $100,000 of the IRA.
Step 1: Total after-tax contributions / Total IRA account balance: ($50,000/ $300,000 = 16.67%)
Step 2: 16.67% x 100,000 = $16,667
Step 3: $100,000 - $16,667= $83,333.
The example illustrates that converting $100,000 from a traditional IRA to a Roth IRA will result in our having to pay additional income tax on 83,333 of income in that tax year. However, there may be a way around this aggregation rule. If an employee’s company retirement plan such as a 401k plan allows rollovers into that company-sponsored plan, then the employee could roll just the pre-tax contributions into that company plan, leaving the IRA with only the post-tax contributions.* This would result in the IRA holding only contributions that have already been taxed, and therefore, a rollover of this amount could avoid the above pro-rata aggregation rules. For self-employed individuals or even part-time independent contractors, it may make sense to open an individual 401k plan for that full or part-time business, particularly if they have made fairly significant non-deductible IRA contributions over the years. In any event, as you can see, there are complex rules relating to Roth IRA conversions, and there is no easy one size fits all answer for all individuals. But, with the present bonus of the option to pay the additional taxes spread over two years as well as the income restrictions being lifted in the 2010 tax year, it may make sense to know all your options. It is also important to note that the decision to convert can be circumvented after the fact through what is called a re-characterization. The re-characterization effectively makes the prior transfer null and void, but the decision must be made by October 15th of the calendar year after the year of conversion. If there were large gains in the IRA account which would result in large taxes, then it might make sense to re-characterize.
Stay tuned. Part two will highlight other significant tax changes for the year.
*Depends on your 401(k) plan. Please see your plan administrator for information on your particular plan. Please talk to your financial advisor and tax advisor for advice on your specific situation prior to executing any strategy as individual situations may vary.
Today, however, there are no income limitations as to who is and who is not eligible to convert. In addition, there was an added change provided by the IRS, which only exists for the 2010 tax year. The change is that the IRS has granted the option to claim 50% of the conversion amount as income in 2011 and the remaining half in 2012. If one elects to defer and pay the tax over the two year period, he or she will pay the tax based on his or her tax bracket for that year. This could be more costly and therefore less advantageous if say the taxpayer expected a bonus or other qualifying event that would make 2012 a higher tax year. Because money in a traditional IRA has never been taxed, any distribution from a traditional IRA is considered income in the year in which it is received. Converting from a traditional IRA to a Roth IRA is considered a distribution, and therefore can substantially impact income taxes due in the year of conversion. It can even throw a taxpayer into a much higher tax bracket. This part of a conversion for tax purposes is very clear. Where it gets a little more complicated is for those tax payers who maxed out on deductible retirement plan contributions, but nonetheless funded a traditional IRA with after-tax contributions in order for the proceeds to grow tax deferred.
Unfortunately, we are not permitted to segregate the pre and post-tax contributions thereby allowing the post-tax contributions exclusively to be withdrawn to avoid income taxation when making a conversion, and a specific three step formula must be followed. Step one is to divide the total after tax contribution by the total IRA account balance to come up with a non-taxable percentage. Step two requires multiplying that percentage by the total amount that is desired to be converted. The quotient reached in step two is subtracted in step three from the total amount desired to be converted.
Example: Let’s say we contributed total after-tax contributions to a traditional IRA over the years of $50,000. And, let’s also establish that the total value of the traditional IRA, (including both pre and post tax contributions totals $300,000). And let’s say that we desire to convert $100,000 of the IRA.
Step 1: Total after-tax contributions / Total IRA account balance: ($50,000/ $300,000 = 16.67%)
Step 2: 16.67% x 100,000 = $16,667
Step 3: $100,000 - $16,667= $83,333.
The example illustrates that converting $100,000 from a traditional IRA to a Roth IRA will result in our having to pay additional income tax on 83,333 of income in that tax year. However, there may be a way around this aggregation rule. If an employee’s company retirement plan such as a 401k plan allows rollovers into that company-sponsored plan, then the employee could roll just the pre-tax contributions into that company plan, leaving the IRA with only the post-tax contributions.* This would result in the IRA holding only contributions that have already been taxed, and therefore, a rollover of this amount could avoid the above pro-rata aggregation rules. For self-employed individuals or even part-time independent contractors, it may make sense to open an individual 401k plan for that full or part-time business, particularly if they have made fairly significant non-deductible IRA contributions over the years. In any event, as you can see, there are complex rules relating to Roth IRA conversions, and there is no easy one size fits all answer for all individuals. But, with the present bonus of the option to pay the additional taxes spread over two years as well as the income restrictions being lifted in the 2010 tax year, it may make sense to know all your options. It is also important to note that the decision to convert can be circumvented after the fact through what is called a re-characterization. The re-characterization effectively makes the prior transfer null and void, but the decision must be made by October 15th of the calendar year after the year of conversion. If there were large gains in the IRA account which would result in large taxes, then it might make sense to re-characterize.
Stay tuned. Part two will highlight other significant tax changes for the year.
*Depends on your 401(k) plan. Please see your plan administrator for information on your particular plan. Please talk to your financial advisor and tax advisor for advice on your specific situation prior to executing any strategy as individual situations may vary.
Friday, January 22, 2010
What is Not Being Addressed in the Health Care Debate....written by Greg Gann
I remember the days when you intimately knew your family doctor, and the same doctor treated you for many, many years. There is great contention and debate today in the U.S. and the rest of the world over how to fix healthcare. Unfortunately, much of the focus and strategies have been based on political ideology and party affiliation. Whether this country shifts from a private pay system to a government sponsored or quasi-government health coverage, there are real healthcare crises that are not even making the radar, but are clearly affecting me personally and most likely you as well. The crisis deals with the tremendous challenges associated with finding a family care practitioner today. Two years ago, my internist left private practice to join as a staff member of a hospital. He could no longer practice medicine the way he wanted and to be able to provide basic support for his family. It wasn’t that he wasn’t “successful”. He already had such abundance that he stopped accepting new patients. He complained that lawyers get paid anytime a client calls seeking professional advice. Yet his time spent in this way remained completely uncompensated. Also, the reimbursements from private health insurance companies and Medicare were so astoundingly low that they literally would not cover his overhead. Malpractice insurance, staff, rent and other office expenses don’t adjust lower just because the reimbursements continually get cut each year. While the medical specialists complain about income cuts put on them from the health insurance industry and the government, they at least can still cover their overhead and maintain a relatively high lifestyle. Having said that, the one specialty that is having a hard time making ends meet is obstetrics, where malpractice insurance alone can cost well over $100,000 per year.
I’m grateful we had our kids when we did because I don’t know who would deliver them if they were being born today. And this is my point. The real health crisis that is not making the debate, and to me is the most fundamental, is that at the rate we are going, few of us are going to have the privilege of selecting our own doctor because there just aren’t enough family doctors or certain specialty doctors left.
When my family doctor quit his practice to join the hospital medical staff, I called about six or seven internists, only to learn that none of them was accepting new patients. I felt like I was seeking membership to an exclusive country club into which I just could not break. On the eighth office rejection, I happened to mention in passing to the doctor’s assistant how disappointed I was that the doctor would not take me as a new patient because I knew from my father who is his patient how good a doctor he was. To this comment, she responded by saying that since I had an in through my father that she was sure that the doctor would relax his stated policy and let me in. Wow! I had made it to the country club at last. I have enjoyed this doctor very much and have a lot of confidence in him. This week the form letter from his office arrived that he was converting his practice to a model known as “VIP” or sometimes referred to as “concierge” medicine. With this model, the doctor who today most likely treats more than 2500 patients will be limiting his practice to the first 500 who sign on. For the privilege of maintaining him as my family doctor, I would have to fork over $2000 per year per family member who he’d treat. This is on top of my exorbitant medical insurance premiums, co-pays, and deductibles. Interestingly enough, his partner is not switching to this new model. However, he is not willing to treat any of his partner’s patients. Additionally, he is no longer willing to participate with insurance plans. So, he will collect from patients the full amount and not just the reimbursement amount of say Blue Cross / Blue Shield. He is shifting the burden of collection to his patients as well as the non-reimbursable amounts. The point is that while Washington is battling over who will pay for medical care, I’m finding it difficult just to find a doctor to whom I can pay because the ones I know have either given up on the entire concept of private practice and work for an institution, or they are not taking new patients, or they are now VIP only, or they will no longer participate with insurance plans. Are we already living in a time period where adequate healthcare is only available for the rich? Baltimore is no doubt one of the medical meccas in the world, so I’m thinking if it’s this difficult here, what’s it like in other parts of the country? I asked this very question of a colleague based in Seattle, and he said that the VIP model hadn’t made it to his coast yet, but knew it would be inevitable.
Spending on doctors, hospitals, drugs, and the like now consumes more than one of every six dollars that we earn. Atul Gawande in his June 1, 2009 New Yorker article entitled, ”The Cost Conundrum” reported that in 2006, doctors performed at least sixty million surgical procedures, which equates to one for every five Americans. No other country comes close to this statistic. And complications from surgery kill some hundred thousand people annually, which is far more than the number of car crash fatalities. Katherine Baicker and Amitabh Chandra, two economists working at Dartmouth, found that contrary to common sense, the more money spent per person on Medicare in a given state, the lower that state’s quality ranking was. Gawande goes on to compare traditional medical models to those of places such as the Mayo Clinic. At Mayo, the core tenet is “the needs of the patient come first”. In a traditional practice or hospital, payment is received based on the numbers of procedures ordered. He goes on to say that if a general contractor were paid based on the number of electrical outlets installed versus overseeing and coordinating the job, then due to that economic incentive, there would most likely be a lot of electrical outlets making their way to the jobsite through a myriad of justifications. Compensation at the Mayo Clinic has nothing to do with the number of procedures ordered. The quality of medical care is the mission, and this is not measured through quantity. An example is given about an internist at the Clinic escorting the patient personally to the cardiologist and consulting as a team. Gwande points out that the greatest challenges for the healthcare industry is modifying the orientation of physicians away from profit and quantity to payment based on quality, which to the author requires collaborative medicine practiced in a way like the Mayo Clinic. I agree with his concerns over procedural based compensation, but I truly believe that the greatest initial obstacle is finding a way for the family doctor, who after all is the first line of defense, to be able to make a living by just being the old-time family doctor that he or she set out to be. Irrespective of whether we are Democrats, Republicans, or Independents, this is where the healthcare debate needs to initiate if we are to cover more people more efficiently, and have a healthier nation as a result.
I’m grateful we had our kids when we did because I don’t know who would deliver them if they were being born today. And this is my point. The real health crisis that is not making the debate, and to me is the most fundamental, is that at the rate we are going, few of us are going to have the privilege of selecting our own doctor because there just aren’t enough family doctors or certain specialty doctors left.
When my family doctor quit his practice to join the hospital medical staff, I called about six or seven internists, only to learn that none of them was accepting new patients. I felt like I was seeking membership to an exclusive country club into which I just could not break. On the eighth office rejection, I happened to mention in passing to the doctor’s assistant how disappointed I was that the doctor would not take me as a new patient because I knew from my father who is his patient how good a doctor he was. To this comment, she responded by saying that since I had an in through my father that she was sure that the doctor would relax his stated policy and let me in. Wow! I had made it to the country club at last. I have enjoyed this doctor very much and have a lot of confidence in him. This week the form letter from his office arrived that he was converting his practice to a model known as “VIP” or sometimes referred to as “concierge” medicine. With this model, the doctor who today most likely treats more than 2500 patients will be limiting his practice to the first 500 who sign on. For the privilege of maintaining him as my family doctor, I would have to fork over $2000 per year per family member who he’d treat. This is on top of my exorbitant medical insurance premiums, co-pays, and deductibles. Interestingly enough, his partner is not switching to this new model. However, he is not willing to treat any of his partner’s patients. Additionally, he is no longer willing to participate with insurance plans. So, he will collect from patients the full amount and not just the reimbursement amount of say Blue Cross / Blue Shield. He is shifting the burden of collection to his patients as well as the non-reimbursable amounts. The point is that while Washington is battling over who will pay for medical care, I’m finding it difficult just to find a doctor to whom I can pay because the ones I know have either given up on the entire concept of private practice and work for an institution, or they are not taking new patients, or they are now VIP only, or they will no longer participate with insurance plans. Are we already living in a time period where adequate healthcare is only available for the rich? Baltimore is no doubt one of the medical meccas in the world, so I’m thinking if it’s this difficult here, what’s it like in other parts of the country? I asked this very question of a colleague based in Seattle, and he said that the VIP model hadn’t made it to his coast yet, but knew it would be inevitable.
Spending on doctors, hospitals, drugs, and the like now consumes more than one of every six dollars that we earn. Atul Gawande in his June 1, 2009 New Yorker article entitled, ”The Cost Conundrum” reported that in 2006, doctors performed at least sixty million surgical procedures, which equates to one for every five Americans. No other country comes close to this statistic. And complications from surgery kill some hundred thousand people annually, which is far more than the number of car crash fatalities. Katherine Baicker and Amitabh Chandra, two economists working at Dartmouth, found that contrary to common sense, the more money spent per person on Medicare in a given state, the lower that state’s quality ranking was. Gawande goes on to compare traditional medical models to those of places such as the Mayo Clinic. At Mayo, the core tenet is “the needs of the patient come first”. In a traditional practice or hospital, payment is received based on the numbers of procedures ordered. He goes on to say that if a general contractor were paid based on the number of electrical outlets installed versus overseeing and coordinating the job, then due to that economic incentive, there would most likely be a lot of electrical outlets making their way to the jobsite through a myriad of justifications. Compensation at the Mayo Clinic has nothing to do with the number of procedures ordered. The quality of medical care is the mission, and this is not measured through quantity. An example is given about an internist at the Clinic escorting the patient personally to the cardiologist and consulting as a team. Gwande points out that the greatest challenges for the healthcare industry is modifying the orientation of physicians away from profit and quantity to payment based on quality, which to the author requires collaborative medicine practiced in a way like the Mayo Clinic. I agree with his concerns over procedural based compensation, but I truly believe that the greatest initial obstacle is finding a way for the family doctor, who after all is the first line of defense, to be able to make a living by just being the old-time family doctor that he or she set out to be. Irrespective of whether we are Democrats, Republicans, or Independents, this is where the healthcare debate needs to initiate if we are to cover more people more efficiently, and have a healthier nation as a result.
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