Times are a-changin’ … So should your documents.

“The line it is drawn, the curse it is cast
The slow one now will later be fast
As the present now, will later be past
The order is rapidly fadin’
And the first one now will later be last,
For the times they are a-changin’.”

Bob Dylan wrote these lyrics to ‘the times they are a-changin’ in September of 1964, while probably examining the political and racial upheaval he saw around him. When I hear the song these days, however, I’m convinced that the last verse is actually about updating business and estate planning documents. Bear with me…

2013 has brought changes to the tax structure that impact all of us and our clients: higher income and capital gains rates, higher estate tax exemptions, expiration of the 2% payroll tax holiday, the extension of portability, and the long-term patch to the Alternative Minimum Tax, to name a few. In the tax world, the times they are almost always a’ changin’, so it makes sense to occasionally review your estate and business documents to make sure this important paperwork reflects these changes appropriately.

Many of our clients’ families are going through transitions. (“The present now will later be past, the order is rapidly fading”). The birth or death of a family member, marriage, divorce, graduation, retirement, changes in jobs, receipt of an inheritance, and similar events often prompt the question: Does this change need to be addressed in my estate planning documents or the organizational documents for my business? If you think the answer might be “yes”, you are probably right.

Many of our clients also come to us because their businesses are going through a transition where the order is changing, or is going to change in the near future. Drawing the proper lines around how the next generation will inherit and manage a business can be done in many different ways. Some arrangements provide a business owner’s heirs with equal shares in managing the business and splitting its profits (and risks), and some arrangements hire a property manager to take over the day-to-day operation while the constantly-fighting children inherit profit rights and nothing more. There are many agreements that fall in between these extremes. There is a lot of room to customize the plan to the business (and family) involved, depending on taxes, family dynamics, and other factors. Some of these transitions go really well and some go terribly wrong. The ones that go smoothly usually involve well thought out written plans, open lines of communication, and children that are on good terms.

I am often asked how often our clients should review their estate and business planning documents. The answer is: whenever the times are a-changin’.

I hope this post has not ruined Bob Dylan’s music for any of our readers.

You can watch Bob Dylan perform ‘The times they are a changin’ at the White House here:


Of Lame Ducks and Taxes

“Lame Duck” is often used to refer to a politician who is known to be in his or her final term of office, when constituents and colleagues look toward a successor. The historical origin of the term is attributed to eighteenth-century England where the term was used to refer to an investor who could not pay his or her debts. Both usages are apropos when referring to the current dilemma facing Congress with the extension of the “Bush Tax Cuts,” also know as Economic Growth and Tax Relief Reconciliation Act of 2001 (often informally referred to as “EGTRRA”).

In my article in this blog last May, I posed the question “What if Congress Does Nothing.” It’s almost seven months later and Congress has, in fact, done nothing with regard to the many provisions of EGTRRA that will expire on midnight on December 31, 2010.

Congress returned from the holiday break this week and congressional leaders met with President Obama yesterday to discuss the tax expiration dilemma. Each side has appointed several negotiators to try to find a compromise. Those negotiations are taking place against the backdrop of a still-divisive post-election climate with and federal deficits continuing at an unprecedented level.

What will happen now? While my guess here is akin to a blind bet at a Vegas gaming table, I believe that Congress may agree on a compromise proposal to extend all of the EGTRRA tax cuts for another two years. As to the estate tax, a similar compromise could be made to reinstate the estate tax exemptions and rates at 2009 levels (i.e. with a $3.5 million exemption and a 45% top rate). However, a slightly less likely possibility is that Congress will simply do nothing and pass the “tax baton” to the next Congress to deal with in early 2011.

The Accidental (Tax-Free) Billionaire

Dan Duncan was the son of an oil-field roughneck. From humble beginnings, Mr. Duncan started his own oil and gas business in 1968 with $10,000 and a truck. Over the years, Duncan grew that business into a prosperous venture which is now known as Enterprise GP Holdings L.P., a publicly traded company (Ticker EPE). At his death on March 28th of this year, Duncan had an estimated net worth of $9 billion and was ranked No. 74 on Forbes list of the world’s richest individuals. It appears that Duncan is the first American billionaire to pass his wealth free of the estate tax since the modern estate tax was originally imposed in 1916.

As we have previously discussed in WealthLawBlog, the federal estate tax is on a one-year hiatus in 2010. In 2009, the first $3.5 million in net worth was exempt from the estate tax, with a top tax rate of 45%. In 2011, the estate tax returns with only a $1 million exemption and a top rate of 55%. Hence, if Duncan had died three months earlier or nine months later, his estate would have been liable for billions in federal estate taxes. 

However, Duncan’s death is not entirely tax free. One quirk in the 2010 estate tax law is an anomaly referred to as “carryover basis.” Generally, under the modern estate tax regimen, while estates are subject to the estate tax, the assets that are subjected to the tax receive a “step-up” in their tax bases equal to the value of such assets as of the decedent’s date of death. This means that the heirs receiving these assets can sell those assets and pay capital gains taxes on only the appreciation in the value of those assets exceeding the stepped-up bases. In 2010, assets receive no step-up in basis except for a limited step-up of $3 million for assets passing to a surviving spouse and $1.3 million for assets passing to other heirs.

In the case of Duncan’s estate, except for these limited exceptions to the step-up basis rule, Duncan’s heirs will inherit the assets in Duncan’s estate with carryover tax bases. If the Duncan heirs sell these assets, then they will pay capital gains taxes on the difference between the sale price of the assets and Duncan’s original basis. Based upon the presumption that much of Duncan’s estate consists of his company shares with a very low basis, the ultimate capital gains taxes payable by Duncan’s heirs could be substantial. Nevertheless, even if the taxes are paid at the increased capital gains rate for 2011 of 20% (increasing to 23.8% in 2013), these taxes are certainly much less than the estate tax rates of 45% to 55%. 

The bottom line: death and taxes are still inevitable. It’s only their timing and severity that varies.

What if Congress Does Nothing?

The clock is ticking! If Congress fails to act by the end of 2010, many significant tax provisions passed as part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (often informally referred to as “EGTRRA”) will simply expire. This “sunset” feature of EGRRRA was enacted so that the law would comply with the Byrd Rule, a rule that allows Senators to block a piece of legislation if it purports to significantly increase the federal deficit beyond a ten-year term. Now the ten-year clock has almost wound down. 

Here’s a summary of the significant changes to the tax code that will occur if Congress does not act:

 Tax Rates. Currently, the top tax rate is 35%. The following table is comparison of this year’s tax brackets with an estimate of the 2011 post-EGTRRA tax rates, including a reinstated 39.6% tax rate: 



Tax Bracket

Married Filing Jointly

Tax Bracket

Married Filing Jointly

10% Bracket

$0 – $16,750


15% Bracket

$16,750 – $68,000

15% Bracket

$0 – $70,040

25% Bracket

$68,000 – $137,300

28% Bracket

$70,040 – $141,419

28% Bracket

$137,300 – $209,250

31% Bracket

$141,419 – $215,528

33% Bracket

$209,250 – $373,650

36% Bracket

$215,528 – $384,860

35% Bracket

Over $373,650

39.6% Bracket

Over $384,860

Capital Gains. If you are currently in the 25% or higher tax bracket, your maximum rate on capital gains is 15%. If you are in the 10% or 15% brackets, the maximum rate is 0%! After EGTRRA sunsets, the top capital gains rate increases to 20% (up to 10% for those below the 25% bracket).  

Qualified Dividends. Similar to capital gains, most corporate dividends are currently taxed at a 15% rate. These dividends are known as “qualified dividends.” After 2010, these dividends will be taxed in the same manner as ordinary income, up to the top 39.6% rate.

Phase-out of Itemized Deductions & Personal Exemptions. Prior to the Bush-era tax cuts, itemized deductions (including charitable donations, home mortgage interest, state and local income taxes, and property taxes) were reduced for higher-income individuals under a phase-out rule. Since 2006, this phase-out rule has, itself, been phased out so that by this year, itemized deductions were no longer subject to any limitations. However, in 2011, the phase out rule returns. Specifically, itemized deductions will be reduced by 3% of AGI in excess of the applicable phase-out threshold (approximately $170,000). The maximum reduction is limited to 80% of the affected deduction amounts. Similarly, certain EGTRRA limitations on the personal exemption phase-out rules will expire after 2010, thus further increasing the effective tax burden for high earners.

Estate Tax. At the time of EGTRRA’s enactment, the federal estate tax exemption amount was $675,000 and was scheduled to increase incrementally to $1,000,000 by 2006. EGTRRA increased the exemption amount to $1,000,000 in 2002, $1,500,000 in 2004, $2,000,000 in 2006, and $3,500,000 in 2009. In 2010, the estate tax (as well as the generation-skipping tax) is repealed. Between 2001 and 2009, the top estate tax rate dropped from 55% to 45%. If Congress does nothing prior to year’s end, the estate tax will be reinstated with a $1,000.000 exemption amount and a top rate of 55%.

Many are optimistic that Congress will act this year to make at least some changes to the tax code, particularly for those individuals with adjusted gross incomes of less than $250,000 and estates worth less than $3,500,000. However, in the wake of this year’s cantankerous debates in Congress over health care legislation as well as the election of Senator Scott Brown in Massachusetts (effectively sapping the Democrats filibuster-proof majority in the Senate), it may be difficult for Congress to find common ground over major tax legislation. The best bet for this may be changes in a “lame-duck” session following the fall elections. Stay tuned!

New Health Care Law Includes 3.8% Medicare Tax on Investment Income

President Obama Sign Health Care Legislation into Law

In the coming months (possibly years), tax lawyers and accountants will be analyzing the ramifications to business of the new health care legislation which was recently signed into law by President Obama. One of the new provisions of this law marks the first time in history that the federal Medicare tax will be extended beyond wages and self-employment income to interest, dividends, capital gains, annuities, royalties and rents. This new tax applies to individuals with adjusted gross income above $200,000 and joint filers over $250,000.

For individuals above the $200,000/$250,000 thresholds, the tax will apply to all “net investment income”. In addition to all applicable income taxes, the new Medicare tax will be 3.8%. For regular wages, the new law also adds an additional 0.9% tax on wages over the threshold amounts (thus increasing the current tax on such wages from 1.45% to 2.35%).

One noteworthy aspect of this provision is that several types of income are excluded from the definition of “net investment income” and hence are not subject to the new tax. First, the tax does not apply to income from the operation of a trade or business. Therefore, the law appears to retain the current law’s exemption whereby the Medicare tax does not apply to S corporation distributions. 

The Medicare tax applies to income that is derived from rental income only if the landlord is a passive investor under the Tax Code’s current “passive activity” rules. Hence, if the landlord is a sole proprietor or an active investor in a partnership, LLC, or S corporation, the Medicare tax does not apply. Note, however, that if the landlord is a sole proprietor or an active investor in a partnership or LLC (but not an S corporation), income from the activity may be considered trade or business income that may already be subject to the Medicare self-employment tax, which the new law separately increases from 2.9% to 3.8% for high earners.

Capital gains are generally included in the new Medicare tax. However, gain from the sale of an interest in a partnership (including an interest in an LLC that is taxed as a partnership) or S corporation is subject to the new tax only to the extent that the gain is attributable to passive investment assets and not property held by the entity which is attributable to an active trade or business.

Finally, the Medicare tax does not apply to distributions from qualified retirement plans. This exclusion extends to distributions from employee profit-sharing and 401(k) plans, IRAs, Roth IRAs, and 403(b) plans from tax-exempt organization.

The new Medicare tax will become effective on January 1, 2013.

Estate Tax Legislative Update

On January 20, 2010, the U.S. Senate took an unusual procedural step in placing HR 4154, the “Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Bill of 2009” directly on the Senate calendar.  In taking this action, the Senate is in the position to completely bypass the Senate Finance Committee, which is the main tax-writing committee in the Senate. As previously reported by my law partner, Jeff Cheyne, the estate tax expired on December 31, 2009 after the Senate failed to act to approve legislation that would have extended the estate tax. 

HR 4154 was passed by the House of Representatives on December 3, 2009 by a vote of 225-to-200. The legislation would permanently extend the current exemption for estates up to $3.5 million per individual and $7 million for married couples and set a maximum rate of 45 percent on estates above this threshold. If passed by the Senate, the legislation would, in effect, retroactively restore the estate tax effective as of January 1, 2010.

I welcome your comments and questions.

New House Bill Would Reform Estate Tax

Charlie Rangel, House Ways and Means ChairmanOn October 22nd, a bill to permanently extend the federal estate tax for 2010 and beyond was introduced by a bipartisan group of Congressional Representatives. All four Representatives are also members of the House Ways and Means Committee – the tax-writing committee in the House. The bill would rescind 2010’s scheduled repeal of the estate tax. In addition, over the next ten years, the bill would increase the federal estate exemption amount and reduce the top estate tax rate as indicated in the table set forth below:



























































2019 or thereafter





After 2019, the $5 million exemption amount would be indexed for inflation. While the introduction of such legislation is often the last time it sees the light of day, the fact that a bipartisan group (two Democrats and two Republicans) introduced the legislation, combined with their common membership on the Ways and Means Committee, may give the bill some traction. Ultimately, Ways and Means Chairman Charlie Rangel will be instrumental in deciding the nature of any legislation that moves out of the committee. Stay tuned!

I welcome your comments and questions!

Just a Little Spackle on the Estate Tax


Caution! The estate tax has a hole in it. Not to worry – a bit of legislative spackle is on the way. 

The estate tax (with its current $3.5 million exemption) is just a few months away from expiring – albeit for one year. Then, if Congress fails to act, the estate tax will reappear in 2011 with a $1 million exemption. This odd scenario exists because of the 10-year expiration of the 2001 tax bill passed early in the Bush Administration.

A recent article in the publication The Hill quotes experts and Congressional staffers saying that Congress will enact a one-year “patch” which will extend through 2010 the current $3.5 million estate tax exemption and tax rate of 45 percent. The congressional staff members indicate that because Congress is busy dealing with healthcare reform, a long-term decision for the estate tax will have to wait until 2010.

Both the Obama administration and Senate Finance Chairman Max Baucus have proposed making the $3.5 exemption and 45 percent top rate permanent. However, Republicans and some conservative Democrats have suggested a $5 million exemption and a top rate of 35 percent. With such splits present not only between the parties but also with the Democratic majority, a one-year “spackle” approach might lead to the scenario described in the blog article by my co-blogger and law partner, Ted Simpson. Under this scenario, election-year gridlock and inaction by Congress could lead to the return of the $1 million exemption in 2011. Spackle may have its limits.

I welcome your comments and questions.