In case you’ve been in a sensory deprivation tank since the ’80s, you know that federal budget deficits have become staggering. In 2011, the United States is scheduled to spend $1.3 trillion more than it takes in. Furthermore, the current national debt as of the date of this letter is more than $15 trillion.

The debate is raging in Washington over how to solve the deficit problem. Lots of our representatives believe that a tax increase is inevitable. From a philosophical perspective, it’s hard to argue that there’s a tax more clearly associated with “the rich ” than estate taxes.

The federal estate tax exemption—the amount that can be passed to kids without having to worry about estate taxes—for calendar years 2011 and 2012 is scheduled to be $5 million for a single person. For a married couple the exemption can be $10 million. The tax rate on the estate in excess of those amounts is a flat 35 percent.

If Congress and the President do nothing prior to the end of 2012, at the beginning of 2013 the exemption amount is scheduled to drop to $1 million, and the top estate tax rate will be 55 percent.

The IRS published statistics a few months ago about federal estate tax returns filed for those who passed away in 2007. What do the statistics tell us about estate taxes then and now?

• Whether the exemption amount ends up being $1 million, $3.5 million, or $5 million, it shouldn’t make a difference of more than about 25 percent in the amount of estate taxes collected for a given year.

• Annual estate tax collections are not a big revenue number, relatively speaking, for the federal government. They represent about 2 percent of the budget deficit, and .2 percent of the national debt.

• A smaller estate tax exemption will probably disproportionately affect the survival of family farms unless special protections are built in.

• A smaller estate tax exemption will probably not disproportionately hurt closely held businesses.

Do these observations provide any assurance about what will happen with federal estate taxes? Unfortunately, no. Feel welcome to keep in touch with me so you can stay in touch with the latest federal estate tax developments.

If you feel your estate plan is not up-to-date or needs a review, please contact us.

AS ALWAYS, PLEASE FEEL FREE TO CALL TO DISCUSS THESE OR OTHER FINANCIAL SECURITY ISSUES OF CONCERN.

There are several issues an estate’s executors and advisers must consider when an S corporation shareholder dies.  Three of the most common are income tax reporting in the year of death, income tax basis of the decendent’s stock passing to heirs and protecting the company’s S corp status during estate administration.

Subchapter S of the Internal Revenue Code allows the shareholders of an eligible small-business corporation to make an election to tax the corporation as a pass-through entity, an S corp, thereby avoiding the double taxation of income inherent in regular C corporation income.

For example, a C corp pays tax on its income at the entity level, then the shareholders pay tax on the income again when it’s paid out as dividends.  An S corp, though, typically does not pay tax at the entity level, but taxable income is reportable on the individual shareholders’ tax returns directly–thereby bypassing the entity-level tax.  This is a tremendous break for the shareholders, and it’s critical that executors and advisers handle S corps appropriately and protect the S election status.

Tax reporting in the Year of Death

 S corp income is prorated on a per-share-per-day basis among shareholders.  When a shareholder dies, income allocable to that person’s shares is prorated between the individual tax return and the estate.  Alernatively, if all affected shareholders agree, the books may be closed at the date of death and pre-death and post-death income allocated among shareholders accordingly.

An analysis of the impact of this election will need to be done in time for filing any affected tax returns, and may impact shareholders’ current year estimated tax payments.

Tax Basis of Inherited Stock 

Following normal tax rules, S corp stock held as the separate property of the decedent will receive a Sec. 1014 step-up in basis to date-of-death or alternate-valuation-date fair market value.  Stock held as community property will also receive a basis step-up as to both the decendent’s and surviving spouse’s community property shares.  For 2010 deaths only an election out of the estate tax regime to modified carryover basis treatment is available, in which case a new set of laws will apply that are beyond the scope of this article.

If S corp stock was used to fund a marital trust or bypass trust at the death of the first spouse, then care should be taken at the second death because only the stock owned by the marital trust will receive a stepped-up basis at the second death.  Stock held in a bypass trust will not receive another step-up at the death of the surviving spouse.

Suspended Losses, Tax Basis Limitations

Generally, S corp losses suspended by tax-basis limitations are personal to the shareholder and cannot be transferred to another person [Reg 1.1366-2(a)(5)].  Thus, suspended losses on stock held by the decedent at death are permanently disallowed to beneficiaries of the stock.

Income in Respect of a Decedent

The stepped-up basis of S corp stock is reduced by the amount of the stock’s fair market value that is attributable to items of income in respect of the decedent (IRD) [Sec. 1367(b)(4)(B)].

For example, if a cash basis S corp held uncollected accounts receivable at the date of death (or applicable alternative valuation date) that would have been treated as IRD if held directly by the decedent, then the basis of the inherited stock is reduced by the IRD amount.  When the coporation receives the accounts receivable payments and the income is reported to the stock beneficiaries, the  stock basis is increased by the amount of the pass-through income.  To the extent any estate taxes were paid by the decendent’s estate, the beneficiaries would be entitled to deduct on their own tax returns the portion of the estate taxes attributable to the IRD.

Postmortem Article published August 2011

Article reprinted with permission from the California Society of CPAs. Unless otherwise stated, views expressed are those of the authors and individuals quoted, not CalCPA.

The end of 2010 will bring an end to a host of new and changing estate and gift tax rules the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 put into action. Alas, effective only in 2010 is the act’s repeal of the estate and generation-skipping transfer (GST) taxes and change in the maximum gift tax rate.

In 2011, after EGTRRA’s sunset, the transfer tax rules are scheduled to revert back to pre-EGTRRA status ($1 million exemption and maximum 55 percent tax rate for gift, estate and GST taxes). Read More

A number of figures used in tax and retirement planning have been updated for 2010.  Most limits for pension and IRA contributions have been unchanged.  For example:

1. The maximum contribution that can be made to a defined contribution plan in 2010 under Section 415 is the lesser of $49,000 or 100 percent of compensation—the same limit as in 2009. Read More

Most closely-held business owners are on a constant search for tax leverage with regard to fringe benefits for the owners and their employees.

Pension plans create income tax deductions for the business, and allow employees to exclude contributions from their taxable income.  However, the employer must include all eligible employees in the plan, and retirement benefits are generally taxable to the participants. Read More

Individuals changing jobs may have substantial pension balances that need to be dealt with.  Often they want to defer taxes on the pension plan balances and transfer the money to another plan over which they have more control.

Others with IRA balances may be interested in making a tax-free transfer to a new IRA custodian, or in splitting the current IRA account for various reasons. Read More

Things to Consider

Those considering starting the estate planning process-perhaps by visiting an attorney about a will or trust-usually have one or more questions:

1. Why do I need to prepare a will or trust at all?
2. Do I need a living trust?
3. How can I protect my young children?
4. How can I protect my special needs relative?
5. How do we arrange our affairs to adequately protect all sides of our blended family?
6. How can I keep peace in the family after I’m gone? Read More

Afraid to open your monthly IRA statements? Has stock market volatility of the last six months altered your retirement plans? We are all familiar with the typical IRA investing in stocks, bonds, and mutual funds, but with recent stock market lows, some investors may be thinking about putting their IRA funds in less conventional investments. Potential alternative investments may include commercial or residential real estate, interests in closely held businesses, Read More