Estate Tax Jeopardy

Posted on July 19th, 2010 in Estate Planning, Newsletter Articles, Taxes by wayne

Who would have believed that Congress would allow for the unlimited estate tax deduction to be implemented, allowing billionaire’s estates, such as George Steinbrenner’s, to pay no estate tax, if the billionaire dies in 2010.

For the rest of us, the lack of Congressional action on the estate tax could provide for a precarious future. Effective January 1, 2011, if your total estate, including your house, vacation home, cars, retirement savings, etc, totals more than $1 million, your  estate could pay 41% of the value of all of your property, exceeding $1 million, to the US Government.  The progressive estate tax rapidly escalates to 55% for estates that exceed $3 million.

Years ago, when the $1 million dollar estate tax exclusion was implemented, few American had an estate worth $1 million, billionaires were virtually unheard of and we would talk about the US government expenses and debt in millions or sometimes billions.  Today, billionaires are fairly common, virtually everything that our government does is in billions or trillions of dollars and there are millions of US citizens that have estates exceeding one million dollars

With the estate tax uncertainty that we face, it is important to know whether you may be affected by a return to the $1million estate tax exclusion.  The best way to do determine this is by developing a simple Net Worth statement.

On the left side of your Net Worth statement, list all of your assets.  Assets would include the value of your house, the value of any vacation property that you own, the value of your cars, the value of your personal belongings, the value of any retirement plans that you have such as 401(k)s and IRAs, the value of your business and the value of any other savings or investments.  On the right side of the Net Worth statement, list all of your liabilities.  This would include mortgages, home equity credit lines, business loans, remaining balances on car loans and any long term credit card debt.

After summing your assets and liabilities, subtract your total liabilities from you total assets to determine your Net Worth.  If you are single and your Net Worth exceeds $1 million, your estate will likely be required to pay estate taxes in 2011, if the current laws remain.

If you are married, perform the Net Worth exercise as a couple.  If your joint Net Worth is under $1 million and it is not expected to significantly increase in the future, a simple will should be sufficient.  However, if the joint Net Worth is over $1 million, but less than $2 million, with proper estate planning, the opportunity to avoid paying estate taxes exists.

When a spouse dies, the second spouse can inherit the full joint estate and pay no estate taxes.  However, if the joint estate is worth over $1 million or will likely be worth more than a million dollars in the future, the ultimate heirs may be required to pay estate taxes upon the death of the second spouse.  This may be avoided by proper estate planning, using devices such as a ‘bypass trust” that avoids all of your joint assets ending up in the surviving spouse’s estate.

For more information on estate planning, see Chapter 10 of my book, Financial Abundance Guide.  If you do not already have a copy, you may download a free copy of my book at www.financialabundanceguide.com

Hopefully Congress will modify the current law to increase the 2011 estate tax exclusion to $3.5 million, an exclusion amount that our president supports.  If so, individuals with estates less than $3.5 million and couples with estates less under $7 million can avoid the estate tax.  However, I find it impossible to predict what our government will do.  Who would have thought that Congress would give the estates of George Steinbrenner and other billionaires a “free pass” in 2010?

Unless your estate is much less than $1 million, I encourage you to call your estate planning attorney before the end of 2010 and determine if your will is written to minimize  estate taxes, even if the estate tax exclusion returns to $1 million in 2011.

New Taxes on the “Wealthy” – Is This You?

Posted on July 19th, 2010 in Health Care, Newsletter Articles, Taxes by wayne

The health care bill, enacted in March, includes two new Medicare taxes on the “wealthy.’  While you may not consider yourself wealthy, there is a reasonable chance that you may have the opportunity to pay one or both of these taxes.  Let’s examine these new Medicare taxes to determine if they might be part of your financial future.

The first tax is a 62% increase (from 1.45% to 2.35%) in Medicare taxes for individuals with earned income over $200K and for couples with earned income over $250K.  While a single person earning over $200K per year is highly compensated, couples need only earn more than $125K each to be engulfed by this new tax.  As usual, the minimum earnings amount is not tied to inflation.  If 1970s style inflation appears in the next few years, earnings of over $125K may become much more common.

The second Medicare tax on the “wealthy” is a 3.8% tax on investment income for singles with an Adjusted Gross Income (AGI) exceeding $200,000 and couples with an AGI exceeding $250,000.   Let’s look at a scenario in which a couple whose earnings are less than $250K could end up paying almost $75K for this new tax.

You and your spouse are 60 years old and owners of a small Sub Chapter S Corporation.  Your joint salaries total $175K.  Through diligent saving over the past 35 years and a small inheritance, you have $1 million dollars in investments to help provide for a reasonable standard of living in your retirement years.

In 2013, the economy finally begins to recover and your business booms, throwing off $75K in dividend income.  At the same time, the stock market finally recovers and you have a 15% return on your investments.

Your AGI from salary and company dividends in 2013 is $250K.  Because of this “wealth,” the $150K in investment income from your savings would be taxed at the then current income tax rate plus you would pay an additional $5,700 in Medicare taxes.

After paying these high taxes in 2013, you decide to sell your business and retire in 2014.  The business sells at the end of 2014 for $1 million.  In 2014 your salaries and dividends from the business total $200K and your investments provide an 8.7% return of $100K .

For 2014, your AGI from salary and company dividends in 2013 is $200K, while your total investment gains (including the sale of your company) are $1.1 million.  The new 3.8% Medicare tax on the “wealthy” would cost you an additional $39,900 above your already high 2014 taxes.

In 2015, you decide to downsize your house, built in 1975 at a cost of $40,000, as well as sell your ski condo that you bought in 1980 for $60K.  Living in Boulder, your house sells for $940K and your condo sells for $460K.  While you have $0 earned income, your investment portfolio increases by approximately 10%, providing $200K in investment income.  Even with the $500K capital gains exclusion for the sale of your home, your total taxable investment income in 2015 is $1 million.  Since $750K of the investment income is taxed at the additional 3.8% rate, the new Medicare tax adds $28,500 to your 2015 tax bill.

The small business owners in the above scenario would hardly be considered “wealthy.”  However, in three years, this couple could pay $74,100 in additional Medicare taxes, thanks to health care reform.

There are several ways that this couple could reduce their taxes, but they did not even know about these new Medicare taxes.  As our government needs more and more tax revenue to sustain its profligate spending, tax planning becomes even more critical.

The good news is that these new taxes do not become effective until 2013.  If you are planning on selling your business or home, tax planning now could save you thousands of dollars in taxes later.  Now, more than ever, it is important to do advanced tax planning with a financial professional who fully understands the tax system.  As our example shows, not understanding the new tax laws can be very expensive.