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The Newsletter of Sanders Financial Management, Inc.
December 2010
by Owen H. Malcolm, CFP®
Last month we lamented the lack of a time machine to look ahead to the future and what Congress would ultimately do with tax legislation. With the President signing the Middle Class Tax Relief Act of 2010 this weekend, we finally have more certainty on the personal tax front than we've had in years. Politics aside, the most uncertain aspect of the bill is that most of the key measures are only put into place for the next two years. That means the next Congress (along with a second-term Obama or first-term president) will be forced into the same exercise in only two years. However, investors can now move forward, take action, and plan for the future.
Payroll Tax Cut
For 2011 only, the payroll tax will be cut by 2%. This gives virtually every working American a 2% pay raise, capped at roughly $2,000 for high earners due to the Social Security wage cap. While this is unlikely to become permanent, additional money in workers' pockets should provide stimulus to our economy and is easily applied by companies on an administrative basis, effective on January 1st.
Extension of Tax Brackets
2010 income tax rates will remain the same for all income levels in 2011 and 2012. This was one of the most bitter points of debate politically, with pressure applied to increase (or revert) to higher levels for the highest two brackets. With certainty on tax rates for the next two years, higher earners have more incentive to proceed with a Roth IRA conversion and spread the tax payments out over 24 months (essentially amounting to a tax-free loan from Uncle Sam).
Extension of Capital Gains & Dividend Tax
Most critical for investors, long-term capital gains tax will remain at 15% (plus applicable state taxes). In addition, "qualified" dividends paid by corporations will continue to be taxed at the same 15% rate. Interest and non-qualified dividend payments continue to be taxed as ordinary income. This adds credence that there will not be a slump in stock prices for high-dividend companies as investors flee their shares prior to year-end before tax rates increase.
Estate Planning
One of the most heated points of debate in the tax bill concerned the level of the estate tax exemption amount, the funds that can be passed to heirs free of any estate tax. While the final figure of $5,000,000 per person rightfully received the most fanfare, there are other even more significant elements of new estate tax law contained in the new bill.
The first is the estate tax rate itself, which is now a very-low (by historical standards) 35%. In addition, the "step up" cost basis method will be used going forward, and 2010 estates will have the ability to elect this treatment with a $5,000,000 exemption, or an unlimited exemption with carryover cost basis treatment. This will aid many middle-class families who are dealing with deaths in 2010 and no step-up in basis on grandma's stock and mutual funds.
Until this new tax bill, it has been critical for spouses to properly title and manage assets so that each spouse could utilize their exemption amount. Poor planning could cause millions of dollars to be lost on careless mistakes like forgetting to re-title real estate or using wrong titles on investment accounts. However, in the new bill the $5,000,000 exemption is portable and can be utilized so that the surviving spouse can still claim a total aggregate $10,000,000 exemption amount per married couple. This should not lead to a laissez-faire approach regarding the titling of assets; however, it should put minds at ease that the penalty for mistakes is not nearly as punitive as it has been in years past. Still, there are many reasons to carefully approach the titling of assets, such as avoidance of probate, protection from creditors and divorcing spouses, and spendthrift provisions for children.
IRA Gifts to Charity
Those over age 70 ½ can distribute up to $100,000 in 2011 from their IRA to qualified charities with no income tax. For generous seniors this can be an excellent way to "test drive" a charity and help them determine what causes and organizations to gift while living, as well as aid them in formulating an additional gifting strategy through their estate planning documents. In 2010 there was a similar tax provision in place, however the charitable distribution was taxed as income, then given back as an itemized deduction. For many this was not an even swap as it placed Medicare and other benefits in higher tax situations.
Conclusion
Although a permanent tax solution would be preferable to a temporary, two year patch, for now there is new found stability, especially after the uncertain environment in the past several years. Politicians are already posturing for the future, staking positions as to whether the new laws are designed to be permanent or if they are merely extensions or temporary measures. In any event, investors can move forward with greater confidence in the coming years and manage their investment portfolios, tax strategies, and estate plans with less concern about radical shifts in the tax law.
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