The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, signed into law December 2010, finally brought some certainty to estate tax, gift and generation skipping tax, at least temporarily.  Although estate planning attorneys now have a better idea as to advising clients in wealth management opportunities, the new law only applies through December 31, 2012. Thus, we may find ourselves back in this position of uncertainty in two years.  Some of the major aspects of the Act are summarized below:

• Estate tax exemptions and estate tax rates: Under President Bush’s Tax Relief Act of 2001, the federal estate tax exemption had increased to $3.5 million dollars in 2009, was unlimited in 2010, and was set to fall all the way back down to $1.0 million dollars in 2011.  This problem was solved for the short term by setting the exemption at $5.0 million dollars for 2011 and 2012.  Thus the first $5.0 million dollars of any estate is exempt from federal estate taxes.  The maximum federal estate tax rate on those estates over $5.0 million dollars was capped at 35%.  This will greatly decrease the number of estates subject to federal estate taxes.  However, once again, this issue will need to be addressed again before January 1, 2013.
• Gift taxes: One of the less discussed aspects of the Tax Relief Act of 2010 is the increase in the gift tax exemption.   Under the Bush Tax Relief Act of 2001, although the federal estate tax exemption kept increasing every year or two, the gift tax exemption was capped at $1.0 million dollars. Thus, individuals were limited to $1.0 million dollars in lifetime gifts before gift taxes were imposed.  Now, the gift tax exemption mirrors the estate tax exemption, and for 2011 and 2012, is $5.0 million dollars. The excess is also taxed at a top rate of 35%. For families with large estates, this will provide a unique short-term opportunity to pass on wealth to one’s children during one’s lifetime without either gift or estate taxes imposed. However, the use of lifetime gifts reduces the individual’s estate tax exemption by the amount of the lifetime gifts. Generation skipping gifts (those passing to grandchildren, great-grandchildren, etc.) was also increased to $5.0 million dollars.
• Portability of unused estate tax exemption: This is a significant development allowing couples to achieve estate tax savings that before usually required an “A-B” trust or “marital” trust to accomplish. Under the new law, an executor may elect to transfer a decedent’s unused tax exemption amount to the decedent’s spouse to combine with the spouse’s own estate tax exemption amount.  Thus, without the use of a trust, a couple can still shelter up to $10.0 million dollars from federal estate taxes.

Conclusion: The new Act brings short-term certainty and increased estate tax relief for everyone for at least the next two years.  It also provides some unique estate tax planning opportunities for those families with very large estates.  However, we may be back to the same uncertainty at the end of 2012 that we were at the end of last year. Thus, it is important to try to stay current as to new developments over the next two years and discuss any questions or proposed estate planning actions with your estate planning attorney, estate planning advisor and/or CPA.

Recent estimates indicate that possibly more than twenty-five percent of all homeowners are upside-down on their home mortgages, meaning that they owe more on their home loan or loans than the fair market value of the residence.  This makes it virtually impossible to sell at a private sale.  When a couple goes through a divorce or dissolution and needs to divide the assets including such a home, what are they to do?  One answer is to walk away from the house, which will lead to foreclosure litigation and a crippled credit rating.  Another possible answer is to complete a “short sale”.

A “short sale” is when a lender agrees to the sale of a property by the owner for less than the amount owed to the lender.  It means that the lender is willing to accept less than the amount owed.  Except for those lenders who are participants in the Home Affordable Foreclosure Alternatives Program (HAFA), the lender may or may not pursue the difference against the borrower.  If the lender does forgive the difference, it likely will not be considered as income by the IRS as long as it complies under the Mortgage Forgiveness Debt Relief Act of 2007(which most primary residences will qualify).

Lenders approve “short sales” when the seller owes more than the house is worth and the lender agrees that the owner has a hardship (e.g. unemployment, divorce, medical emergency, bankruptcy, death).  The lender usually requires the owner provide a financial statement, hardship letter, tax returns, W-2s, pay stubs, bank statements, and a market analysis or list of comparable sales for the property.

For a “short sale” to work, you must have a cooperative lender and a patient buyer.  The process usually takes several months.  The time frame is typically as follows:  Bank acknowledgment-10 to 30 days; assignment of a negotiator-30 to 60 days; appraisal ordered-a few weeks; review of the file-14 to 30 days.  If all goes well, the bank will issue a “short sale” approval letter.  If the buyer is still interested, the property can close.

But understand that the deficiency balance can be handled three (3) different ways by the lender:

• The lender may agree to cancel the entire deficiency balance;
• The lender can attempt to collect the deficiency balance from the seller after the property has closed; or
• The lender may require the seller to sign an unsecured promissory note for the deficiency balance as a condition of agreeing to the “short sale”. If the new note amount is for less than the balance of the original debt, the difference would be considered a canceled debt.

It is important to realize that you must negotiate for the release of both the property lien and the underlying personal debt secured by the note. If you fail to do this, the lender may not forgive the personal debt, and it will survive the “short sale” and become a collection matter.

Effective April 5, 2010, those lenders who participate in the Home Affordable Foreclosure Alternatives Program (HAFA) must fully release borrower from future liability for the first mortgage debt and, if the subordinate lien holder receives an incentive under HAFA, that debt as well. HAFA is part of President Obama’s Making Homes Affordable Program. It provides incentives to lenders who help borrowers modify their loan or help them avoid foreclosure through “short sales”. However, HAFA is not available for FHA or VA loans, and, with respect to other liens, applies only if the lender has chosen to participate in the program.

Obviously, not all sellers nor all properties qualify for a “short sale”.  However, in today’s economy, lenders have been far more willing to consider “short sales” than in the past; particularly, if it makes more financial sense than to foreclose.  For those suffering financial hardship and have no equity in their home and needing to sell their residence quickly, this certainly is an option worth discussing with one’s realtor, lender and attorney.

In a future article, I will be discussing the implications that The Mortgage Forgiveness Debt Relief Act of 2007 has on the taxability of the cancelled debt amount. If you complete a “short sale”, the last thing you would want to receive in the mail is a 1099-C indicating that you owe taxes on the cancelled debt amount!

To the surprise of everyone in the estate planning community, Congress failed to address a critical estate and generation-skipping tax matter before the end of 2009, resulting in the repeal of the federal estate tax.  However, this repeal is for 2010 only.  In 2011, the exclusion for federal estate tax reverts back to $1,000,000.  How is this possible, and what effect does it have on couples’ estate plans, particularly second marriages?

Since 2001, the federal estate tax has been gradually phasing out, with an increasing exclusion from federal estate tax each year.  In 2009, the exclusion increased to $3,500,000. In 2010 however, the federal estate tax disappears, only to return in 2011 with only a $1,000,000 exclusion.  To further complicate things, although the federal estate tax disappears in 2010, the unlimited step-up in basis for inherited assets also disappears; and a decedent’s estate is permitted to increase the basis of assets by only up to a total of $1.3 million with an additional $3 million if there is a surviving spouse.  How does this affect estate planning?

Many couples’ estate plans were written to shelter the exclusion at the death of the first spouse by using a “by-pass” or “shelter credit” trust, and having the balance pass to a spouse (in trust or outright)  or possibly to the children of a first marriage.  Under the current law, the credit shelter trust may be either underfunded or overfunded or, in 2010, not funded at all because no exclusion amount applies.  With estate plans for second marriages where often an individual wants to provide for both a spouse and children from a first marriage, if nothing is allocated to the credit shelter trust (for the benefit of one group of beneficiaries) then everything will go to the remaining group of beneficiaries, and the result may certainly be something other than what was intended.  In 2011, when the exclusion is no longer unlimited but reverts back to $1,000,000, a completely different but equally problematic group of issues arise, also possibly resulting in an estate plan other than what was initially desired.

If you have a trust or trust language in your will, you need to be aware of these issues.  You should have your estate plan reviewed by your estate planning attorney, particularly if your immediate health is an issue, to make sure that it effectuates your intentions and wishes.  It also does not hurt to try to follow this topic in the news.  Congress will eventually address these issues, probably either this year or next.  We just don’t know when or what will be the end result. Stay tuned to our blog and we will report any new developments!

As the end of the year approaches, the following simple tax tips can keep taxes as low as possible.

1. Charitable gifting. Charitable donations may be used as deductions against your taxable income.  However, all charitable donations must be supported with written receipts unless under $250 in which case a bank record is sufficient.  Also, donations of services or your time are not tax deductible.
2. Gifting in general. Each individual may gift up to $13,000 per year to an unlimited number of individuals without filing a gift tax return.  Any gifts over $13,000 per year reduce the lifetime gift tax exclusion of $1,000,000.  Once the lifetime exclusion is exhausted, gift taxes must be paid.
3. Pay property taxes early. Real estate taxes are deductible.  For taxes due early next year, if you pay them this year, you can use them as a deduction.
4. Sell poor performing securities. Losses can be offset against gains reducing any capital gains.  Excess losses can be deducted, but only up to $3,000 per year.
5. Increase retirement plan contributions. Retirement plan contributions reduce taxable income.
6. Increase business expense purchases. Purchases of business equipment, supplies, etc., can be used as taxable deductions.
7. Maximize necessary medical expenses. The purchase of prescription drugs in bulk, eyeglasses, health insurance premiums, and doctor bill payments can be used as deductions.  However, medical expense deductions are limited to the amount exceeding 7-1/2% of your adjusted gross income and only can be used if you itemize your deductions.

Following any of the above-described recommendations should help reduce your tax liability or increase your refund next spring.

In 2008, the IRS amended Code Section 152(e), the section which addresses the subject of the child dependency exemptions for divorced or separated parents. The old rule and procedures have been changed dramatically.

Here is a summary of the dependency exemption requirements:

• The child must be your son, daughter, stepchild, foster child, brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them.
• The child must be (a) under age 19 at the end of the year, (b) under age 24 at the end of the year and a full-time student, or (c) any age if permanently and totally disabled.
• The child must have lived with you for more than half of the year.
• The child must not have provided more than half of his or her own support for the year.

If the child meets the rules to be a qualifying child of more than one person, you must be the person entitled to claim the child as a qualifying child.  (To read the special test for a qualifying child of more than one person, click here.

In most cases, but not always, a child of divorced or separated parents will qualify as a dependent of the custodial parent.  However, in a divorce or separation occurring after December 31, 2008, the noncustodial parent may be able to claim the exemption for the child if ALL of the following apply:

1.

The parents:

a.

Are divorced or legally separated under a decree of divorce or separate maintenance,

b.

Are separated under a written separation agreement, or

c.

Lived apart at all times during the last 6 months of the year.

2.

The child received over half of his or her support for the year from the parents.

3.

The child is in the custody of one or both parents for more than half of the year.

4.

The custodial parent signs Form 8332 (or a written declaration) that he or she will not claim the child as a dependent for the year, and the noncustodial parent attaches this written declaration to his or her return.

So the determination of who is the “custodial parent” for IRS purposes is determined by these tests and calculating whom the child has resided with the greater number of nights during the year, regardless of the terms of the divorce decree! Additionally, beginning in 2009, the custodial parent can unilaterally revoke the release of a child exemption for calendar years 2009 and beyond regardless of when the release was made. The parent claiming a dependency exemption is also entitled to benefit from a Child Tax Credit and any allowable Hope or Lifetime Learning Educational Tax Credits. To read more about the rules, click here to review IRS publication 504. If you want to print off Form 8332, click here.

In summary, parents divorced or separated in 2009 should keep track of the number of nights the child stayed in each home.  Attaching pages from a divorce decree or separation agreement instead of Form 8332, as had been allowed in the past, won’t be acceptable. The noncustodial parent must attach Form 8332 or similar statement signed by the custodial parent. Plan ahead and document the necessary information; and if you are the noncustodial parent and you are claiming the tax exemption, don’t forget to attach the executed form 8332 with your return. Of course in order to fully understand all of the implications of the IRS code as they apply to your particular facts, I suggest that you consult an experienced accountant or tax attorney.

The IRS is treating the stimulus checks as if they were tax refunds. On their website, the IRS indicates that the amount of the stimulus check will be reduced or seized if :

• You are single and your net income tax liability is less than $600. If you file Form 1040 net income tax liability is the amount shown on Line 57, plus the amount on Line 52.
• You are married and your net income tax liability is less than $1,200.
• You are single and your adjusted gross income (AGI) is more than $75,000. On Form 1040, AGI is the amount on Line 37.
• You are married filing a joint return and your AGI is more than $150,000.
• You owe back taxes that reduced your payment.
• You have non-tax federal debts such as unpaid student loans or child-support obligations that reduced your payment.

If the IRS is reducing or seizing your stimulus check, they are supposed to mail you a letter of explanation.

So what do you do if you and your spouse have filed a joint return and your spouse owes back child support if you want to avoid having the IRS seize your share? Well, you may fall in the category of what the IRS calls an “injured spouse”. To get your share of the stimulus payment, you can file Form 8379, Injured Spouse Allocation. You will then get your share of these payments, and your spouse’s share will be applied to his or her past-due federal or state income taxes or non-tax federal debt such as student loans and child support.

If you are wondering where your stimulus check is, you can initiate an inquiry to the IRS by clicking here.

Also, remember that the IRS NEVER initiates any email to taxpayers, so don’t fall for one of those internet scams about receipt of your stimulus check!