Individual Tax and Estate Planning for Lawyers

President Obama's proposed budget for fiscal year 2013 includes a number of provisions that would impact individual taxpayers, especially partners in law firms and other high'net-worth lawyers. Those key budget proposals include:

• Replacing alternative minimum tax. President Obama is proposing that the alternative minimum tax be replaced with the “Buffett Rule,” named for billionaire businessman Warren Buffett. Under the “Buffet Rule,” individuals with annual income of $1 million or more would pay a minimum of 30% in federal taxes.
• Ending some Bush-era tax cuts. The Bush-era tax cuts, which were extended in 2010 by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act, are scheduled to expire on Dec. 31, 2012. The budget proposes to let the lower tax rates expire for taxpayers with household income over $250,000 per year, reinstating the 36% and 39.6% brackets.
• Changes to tax rates for qualified dividends. The current maximum income tax rate on qualified dividends, in effect through 2012, is 15%, and in 2013, qualified dividends are scheduled to be taxable as ordinary income. In the proposed budget, the 15% maximum income tax rate on long-term capital gains will continue, except for upper-income taxpayers.
• Enacting a 60-day rollover for inherited retirement benefits. Generally, assets can be moved from a tax-favored employer retirement plan or from an IRA into or an eligible retirement plan without adverse tax consequences. The only way for a beneficiary (other than a spouse) to complete the rollover is through a direct trustee-to-trustee transfer. The budget proposal would permit non-spousal beneficiaries to roll distributions over to an inherited IRA within 60 days, effective for distributions after 2012.
• Keeping old estate tax limits. President Obama would like to see the current estate tax (which is set to expire at the end of the year and go back to the pre-Bush tax levels of $1 million and a top rate of 55%) stay at the 2009 tax law limits of $3.5 million with a 45% tax on the excess for both the estate tax and generation skipping tax.
• Making portability permanent. Portability endeavors to simplify the estate tax system by avoiding the need for families to undertake complex planning to maximize the use of both spouses' exclusions. It allows a surviving spouse's estate to use any unused federal estate and gift tax exclusion based on the last deceased spouse. Currently scheduled to sunset on Dec. 31, 2012, the administration wants to make portability permanent. (As a planning note, we do not believe you should rely on portability. It is a “fail safe” only in certain situations.)
• Changing tax rates for long-term capital gains. The current 15% maximum income tax rate on long-term capital gains would continue for taxpayers with adjusted gross income up to $200,000 ($250,000 joint), indexed from 2009. The proposals include a 20% tax rate on long-term capital gains beginning in 2013 for taxpayers with adjusted gross income over $200,000 ($250,000 joint), indexed from 2009. In addition, the 18% tax rate for assets purchased after 2000 and held for more than five years would be eliminated.
• Eliminating a flat tax on carried interests. Currently, managers of private equity and hedge funds pay 15% on carried interests. This proposal would tax carried interests at ordinary income tax levels, instead of a flat 15% rate.
• Limiting the value of itemized deductions. The proposal would limit the tax rate at which high-income taxpayers can reduce their liability to a maximum of 28%. Thus, married taxpayers filing jointly with income of more than $250,000 and single taxpayers with income of more than $200,000 would be impacted.
• Changes to minimum required distributions. The administration proposes to exempt participants and IRA owners from having to take required minimum distributions if the aggregate value of their qualified plan and IRA benefits does not exceed $75,000.

Other proposed changes include:

• A minimum term of 10 years for grantor retained annuity trusts (“GRATs”);
• Elimination of the estate planning use of intentionally defective grantor trusts;
• A consistency requirement and a reporting requirement for the basis of property acquired from a decedent;
• Modifications to the rules on valuation discounts; and
• A limit to the duration of the GST exemption for generation-skipping trusts to only 90 years.

Key Points to Consider Now

These proposals, and any compromises that may result, would leave individuals with less planning opportunities than currently exist. What actions should law firm partners and other high'net-worth lawyers consider now?

• Use the $5,120,000 lifetime gift exclusion while it is still available.
• Plan for your state estate tax exposure. Despite the federal estate tax exemption for death taxes, many states have “decoupled” from federal treatment and have exclusion amounts that are significantly lower than the current federal level. For example, New Jersey only exempts $675,000, New York exempts $1 million, and Connecticut exempts $2 million.
• Complete proper estate planning. Even if portability becomes permanent, it is not a substitute for estate planning.
• Use credit shelter trusts which provide additional benefits beyond the use of each spouse's applicable exclusion amount. They ensure that assets contained in the credit shelter trust pass to children of the couple and not to the family of a new surviving spouse. Further, not only will the appreciation on assets contained within the credit shelter trust not be subject to estate tax, the assets in the credit shelter trust are protected from creditors.
• Set up short-term GRATs now and consider proper use of long-term GRATs. GRATs, even if required to have a longer duration, can still be an effective strategy to pass wealth income tax-, gift tax-, and estate tax-free.

It is clear that now is an ideal time for lawyers to examine their estate plans and discuss the implications of the current proposals with their trusted adviser and plan accordingly.

Jacob Weichholz, CPA, MBA, is a member of this newsletter's Board of Editors and a director at J.H. Cohn LLP. He leads the Law Firms Industry Practice in New York and has been providing services to law firms on tax, accounting and consulting matters for more than 30 years. He can be reached at [email protected] or 646-625-5709. Ira S. Herman, MS, CPA, CEA, is a J.H. Cohn partner and director of the firm's Trust and Estate Practice. With 40 years of experience, he has specialized expertise in financial management as it relates to personal, business, retirement, and estate planning. He can be reached at [email protected] or 973-618-6245. Circular 230 Notice: In compliance with U.S. Treasury Regulations, the information included herein (or in any attachment) is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of i) avoiding penalties the IRS and others may impose on the taxpayer or ii) promoting, marketing, or recommending to another party any tax related matters.