In life, George Steinbrenner beat the Red Sox. In death, he beat the IRS.
Steinbrenner’s death on July 13 occurred six months after the federal estate tax expired. Forbes magazine estimates the Yankees owner’s net worth was $1.15 billion, so the timing of Steinbrenner’s death could save his heirs up to $500 million in federal estate taxes.
But future heirs may not be so lucky. The federal estate tax is scheduled to return with a vengeance on Jan. 1, 2011, imposing a levy of up to 55% on estates valued at more than $1 million. And the same congressional paralysis that allowed the tax to expire in 2010 could thwart efforts to pare it back, estate planning attorneys say.
A $1 million exemption would affect a lot of families that are well out of Steinbrenner’s league. “You take a home, an IRA or 401(k) retirement account, some other savings and you get to $1 million pretty easily,” says Richard Behrendt, senior estate planner for Robert W. Baird and a former IRS attorney.

ESCAPING ESTATE TAX: Famous folk who have died this year
Families who live in areas with high property values are particularly vulnerable, says Clint Stretch, tax principal for Deloitte Tax who lives outside Washington, D.C. “People in my neighborhood bought a house for $32,000 in the ’60s, and now it’s worth $1 million,” he says. “If they’ve got anything else, they would be paying an estate tax.”
And for truly wealthy families, estate taxes could influence life-or-death decisions. But more on that later.

Congress
The roonal inaction ts of the estate tax disarray date back to 2001, when Congress voted to gradually raise the estate tax exemption while cutting income tax rates. The phase-out ended in repeal of the tax in 2010. But like the Bush administration’s income tax cuts, the reduction in the estate tax is scheduled to expire at the end of this year.
Right up until the end of 2009, most estate tax attorneys expected Congress to step in and reinstate the tax. That didn’t happen - raising doubts about whether Congress can agree on a fix that will prevent a more punitive tax from rising from the grave in 2011.
“Nine years ago I would have told you there was no chance we would have a year of repeal and no chance we would go back to the $1 million exemption,” says Beth Kaufman, a partner with Caplin & Drysdale in Washington, D.C., and former associate tax legislative counsel for Treasury’s Office of Tax Policy. “Now that we’ve gotten to the year of repeal, it’s hard to say that something is impossible any more.”
Historically, wealthy individuals have used a variety of strategies to mitigate estate taxes, including giving away a large portion of their wealth while they’re still alive. Individuals can give their children, relatives and others up to $1 million during their lifetimes without incurring federal gift taxes, Kaufman says. In addition, individuals can give away an annual amount without reducing their exemption for gift or estate taxes. In 2010, the annual gift tax exclusion is $13,000 per recipient and individuals can give away that amount to as many people as they want. Many wealthy families also reduce the size of their taxable estates by giving money and other assets to charity.
But those strategies aren’t practical for families who have most of their wealth tied up in their primary residences and retirement savings, Kaufman says. “You’re not going to give away your house, because you’re living in it,” she says. Taking withdrawals from retirement plans will trigger income taxes, plus a 10% penalty if the plan owner is under 59½.

Proposed fixes
The Obama administration has proposed returning the estate tax to its 2009 level, with a $3.5 million exemption and a 45% rate on assets that exceed that amount. The House approved the administration’s proposal last year, but Republican opponents blocked action in the Senate.
Last week Sens. Jon Kyl, R-Ariz., and Blanche Lincoln, D-Ark., re-introduced legislation that would exempt up to $5 million from estate taxes and impose a 35% tax rate on assets that exceed that amount.
“In just six short months, American taxpayers will face the largest tax hike in history unless Congress acts,” Lincoln said in a statement. “It is estimated that more than a half-million American families will pay the estate tax over the next decade, and the lack of congressional action creates a tremendous amount of uncertainty for these families, small-business owners and farmers.”
But political partisanship has made compromise increasingly difficult, says Melissa Montgomery-Fitzsimmons, director of wealth planning for First Western Trust Bank in Denver. “Given the fact that we’re in an election year, the most likely thing to happen is that the laws will not change, and we will go back to $1 million of exemption and a 55% rate,” she says.
Plus, reinstating the estate tax with a lower exemption would provide lawmakers with a back-door way to raise revenue, says Jason Smolen, an estate tax attorney at SmolenPlevy of Vienna, Va. “If you could do nothing and get more money, it’s better than voting to raise taxes to get more money,” he says.
Stretch is more optimistic that Congress will resolve the issue before the end of the year. He believes an estate tax with a higher threshold than $1 million - possibly somewhere between the one in the House-passed bill and the one proposed by Kyl and Lincoln - will be included in legislation preventing the middle-class tax cuts from expiring.
That legislation has real urgency, because without it, millions of middle-class Americans will see their taxes go up on Jan. 1, Stretch says. The higher taxes “would come out of people’s paychecks almost immediately,” he says. “If there’s any sanity left in our political system, it will take care of middle-class tax cuts before January and at that moment in time they’ll take care of estate tax.”
Stretch says there’s a good chance the House will extend the middle-class tax cuts and address the estate tax before the midterm elections, possibly as early as this month. But the Senate probably won’t take up the issue until after the elections, he says.

Retroactive tax unlikely
In the meantime, the list of wealthy estates that will escape federal estate taxes will no doubt continue to grow. In addition to Steinbrenner, families of real estate magnate Walter Shorenstein, Texas pipeline tycoon Dan Duncan and Taco Bell founder Glen Bell will not have to worry about federal estate taxes. J.D. Salinger’s heirs will also get a tax break, although establishing the value of the reclusive author’s estate could take years.
“If there’s ever a good time to die, 2010 is certainly it for the wealthy individual,” Kaufman says.
Shortly after the estate tax expired, there was widespread speculation that Congress would reinstate it and make the tax retroactive to the beginning of 2010. But even if Congress agrees on an estate tax fix, it’s unlikely lawmakers will be able to make it retroactive, Behrendt says. Families of billionaires who have died this year have the money and wherewithal to fight the tax all the way to the Supreme Court, he says.
“At some point, it becomes impractical to bring it (estate tax) back,” Behrendt says. “George Steinbrenner’s death in mid-July really underscores that reality.”

Life-or-death tax implications
As repeal of the estate tax loomed at the end of 2009, wealthy families had an incentive to keep ailing parents or grandparents alive until Jan. 1. This year, in what sounds like an episode of Law & Order, heirs stand to benefit if wealthy benefactors die before midnight on Dec. 31. While outright homicide seems unlikely, estate-planning attorneys say they can envision situations in which the prospect of onerous estate taxes influences family members’ decision to discontinue a relative’s life support.
It could also cause some wealthy people with terminal illnesses to hasten their own demise, Behrendt says. “The fact is that our tax laws are influencing people’s decision to live or die.”

Congress will likely act to extend tax cuts for the middle class to avoid choking off the fragile economic recovery, key congressional Democrats said on Tuesday.

House Democratic Leader Steny Hoyer said he expected the House of Representatives to push to extend middle class tax cuts before they expire at year end, but suggested cutting taxes for the wealthy is less urgent.

“What you want to do is stimulate at this point in time, so you certainly do not want to increase taxes on the middle class, middle-income working Americans,” Hoyer told reporters.

President Barack Obama and his Democratic allies in Congress have vowed not to raise taxes on individuals earning less than $200,000 or couples making less than $250,000.

Hoyer said discussion is underway between House Ways and Means Committee Chairman Sander Levin and Senate Finance Committee Chairman Max Baucus on the shape and timing of legislation. Those two tax writing committees will take the lead in developing the legislation.

“The goal is to get it done before they expire,” Hoyer said.

Baucus told reporters that lawmakers were still weighing the details of the legislation, including the tax rate for dividends and wealthier families.

“Clearly we will want to extend the middle income tax cuts at the very least,” Baucus said.

Without congressional action, the tax cuts enacted under President George W. Bush will expire at the end of the year. Current tax rates would rise for most income groups to about 28 percent, 31 percent, 36 percent and 39.6 percent from 25 percent, 28 percent, 33 percent, and 35 percent, respectively.

Investors are watching because under current law, tax rates on the wealthy for dividends would be treated as ordinary income in 2011, meaning they would be taxed as high as 40 percent.

Obama has proposed extending the tax rates for individuals earning less than $200,000 and for families earning less than $250,000 but letting the rates rise back to 36 and 39.6 percent for wealthier income groups.

Obama also proposed raising tax rates on capital gains for the upper-income brackets to 20 percent from the current 15 percent.

Senate Democratic leaders met this morning with Obama to discuss the legislative agenda for the rest of the year. Democrats are facing a tough election cycle with unemployment stuck near 10 percent and Republicans poised to pick up a number of Democratic seats.

Tax-writers in the House are considering a one-year extension of the lower rates for the middle class and a two year extension on a fix to prevent millions of Americans being hit with the alternative minimum tax, originally intended to ensure the rich pay some taxes. That plan would cost $270 billion over 10 years.

DRAG ON DIVIDEND STOCKS

One dilemma for lawmakers and the Obama administration, though, is offsetting the budget impact of keeping dividend tax rates from spiking to 40 percent in January.

Congressional budget rules will allow lawmakers to extend middle income tax cuts without spending cuts or revenue increases to offset their cost. But that is not the case for any extended tax breaks for the wealthy.

Making all the middle class tax rates permanent and extending other popular programs such as child tax credits and relief from the marriage penalty alone would cost $1.3 trillion over 10 years, according to the congressional Joint Committee on Taxation

Several investment analysts predict resolution of the Bush tax cuts will drag into late November and December, after the November mid-term elections.

“It will likely be so expensive for Congress to deal with the expiring 2001 and 2003 tax cuts that there will be no way to pay for it all,” Concept Capital analyst Anne Mathias told investors this month.

“This uncertainty could be challenging for portfolios heavily concentrated in dividend-paying stocks as confusion could lead to unpredictable behavior in advance of year-end,” she added.

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In recent years, the Internal Revenue Service has paid individual awards as high as $1 million to folks informing on tax cheats. And that was under an old program in which amounts were discretionary and capped at 15 percent.

In 2006, a new federal law restructured the IRS whistleblowers program to pay 15 to 30 percent of the taxes and penalties recovered. These are for cases in which taxes and penalties top $2 million for individuals who make more than $200,000 a year.
“It’s designed so we are not dealing with mom and pop type taxpayers, but higher-income folk,” said Stephen Whitlock, 55, director of the IRS Whistleblowers Office.
Even informants who participated in the tax violations may get rewards if they did not plan and initiate them. Bradley Birkenfeld, who admitted helping wealthy clients hide assets in foreign tax havens, claimed that his later whistle-blowing saved taxpayers billions. But in January, the former UBS banker reported to federal prison start a 40-month term for his role in his Swiss employer’s tax-avoidance schemes.

But don’t expect a quick payoff. The process can take three to five years, Whitlock said.
And it won’t be enough to merely report overhearing a guy on the golf course bragging that he stiffed tax collectors by squirreling away millions in a Swiss bank or the Cayman Islands, said Michael Sullivan, a former federal prosecutor whose Atlanta firm represents wannabe tax tattlers. The IRS wants solid evidence like records and account numbers.

“Typically, the informant had a business relationship of sorts, either as a current or former employee, or perhaps as a competitor,” Whitlock said. “Some had a personal relationship.” Like a scorned ex-spouse? “Can be.”

Tips under the old scheme are still in the lengthy audit and collections process. Payments to informants under that program peaked in 2006 at $24 million, dropped to $13.6 million the following year, and then rose to $22 million from $155 million collected in 2008. The median award works out to about $30,000 under the discontinued scheme, Whitlock said.

The old program did not target high-dollar cases and was hardly publicized. Before 2007, someone searching for whistleblower information on the IRS Web site found nothing, he said.

Now, the Whistleblower’s Office gets 30 to 40 tips a month about alleged noncompliance of at least $2 million, the office’s threshold. An additional 200 a month fall below that and are passed on to other IRS investigators, said Whitlock, whose staff has grown from four to 17 and has a new computer system.

The first cash awards under the new program could be made this year. “We expect to pay some,” Whitlock said. “I don’t know how many.” But, he went on, “things can happen, and there aren’t proceeds. Taxpayers can come in with an amended return and show an operating loss.”

Even though nothing has been paid out under the new, more lucrative scheme, a cottage industry of whistleblower-assisting attorneys has materialized. There are even blogs, like www.whistleblowerlawyerblog.com. And some attorneys are crowing about cases that haven’t paid off yet.

A Miami-based law firm said it made a $4.4 billion whistleblower tax submission in 2008, beating its own, self-described record of $2 billion six months earlier. Rival attorneys in various blog postings noted that divulging details might hurt an IRS investigation while tipping off the alleged tax cheat.

Whitlock, a lawyer by training, declined to comment on the cyberspace fracas between lawyers. He did say that an attorney was not needed to make a submission, but that it might be a good idea to seek legal advice on how informing might affect a person’s job or relationships.

Atlanta attorney Sullivan says his firm is juggling about 15 tax whistleblower cases.
“Claims run the gamut from people in the financial services industry, hedge funds and real estate to smaller ones from folks who feel like their employers are abusing independent contractor status, say, by not paying withholding taxes. There’s a great emphasis right now on offshore [bank] issues, which are priority of the IRS.”

First-Time Homebuyer’s Credit Extended

The first three months of 2009 have seen a flood of new federal tax developments. We’d like to highlight some of the more important federal tax developments for you. As always, please give our office a call or send us an e-mail if you have any questions about these developments.

2009 Recovery Act
In February, Congress passed a nearly $800 billion economic stimulus package with significant tax incentives for individuals and businesses. Many of the incentives are temporary so taxpayers need to be proactive this year not to miss them. The Economic Recovery and Reinvestment Act of 2009 (2009 Recovery Act) gives individuals an extended and enhanced first-time homebuyer tax credit, a new Making Work Pay credit, a new vehicle sales and excise tax deduction, improved energy efficiency tax breaks, and more. The 2009 Recovery Act gives businesses extended bonus depreciation and Code Sec. 179 expensing, many expanded energy tax incentives and an expanded net operating loss carryback for small businesses. Since President Obama signed the 2009 Recovery Act into law on February 17, the IRS has issued guidance on many of the tax incentives.

Making Work Pay Credit
Effective April 1, 2009, employers have started withholding at reduced rates to reflect the Making Work Pay credit. The credit is automatic and many individuals will see an immediate increase in their take home pay. However, married couples whose combined incomes place them in a higher tax bracket and individuals with more than one job may want to submit a revised Form W-4 to their employers to ensure that enough withholding is held. Our office can help you determine if you should submit a revised Form W-4 to your employer.

Economic Recovery Payments
The 2009 Recovery Act authorizes one-time payments of $250 to individuals receiving Social Security benefits, disabled veterans and others on fixed incomes. The Social Security Administration, which will be sending the bulk of the one-time payments, has announced it will start making the one-time payments by mail and direct deposit in May 2009.

Help for Taxpayers
IRS Commissioner Douglas Shulman announced in January that the agency will be sensitive to taxpayers stung by the recession. The IRS will consider suspending collection actions, granting short-term extensions of time to pay, allowing taxpayers to miss a payment under an installment agreement, and revisiting offers-in-compromise to help distressed taxpayers. The IRS chief has also said that help will only be given to taxpayers who ask and taxpayers must have a history of compliance.

Net Operating Losses
The 2009 Recovery Act allows an eligible small business to carry back its 2008 net operating loss (NOL) for three, four or five years. For fiscal year taxpayers, this applies to the NOL for the tax year either beginning or ending in 2008. To qualify for the new carryback provision, a small business must have no greater than an average of $15 million in gross receipts over a three-year period ending with the tax year of the NOL. The IRS issued guidance on the new carryback in March and reminded taxpayers about some special elections to take advantage of the new provision.

Offshore Accounts
In March, the IRS invited individuals and businesses to disclose unreported assets in foreign bank accounts. In exchange for full disclosure by taxpayers not already under investigation, the IRS will agree not to criminally prosecute tax evaders. Taxpayers must pay all back taxes plus interest and penalties, although the IRS will waive the 75 percent fraud penalty.

Cost-Sharing Arrangements
At year-end 2008, the IRS issued temporary regulations making some taxpayer-friendly changes to the cost-sharing arrangement rules under Code Sec. 482. A cost-sharing arrangement is an agreement where the parties share the costs of developing one or more intangibles in proportion to their shares of the reasonably anticipated benefits from their individual exploitation of the interests in the intangibles assigned to them under the arrangement. The IRS has identified the transfer of intangibles outside the U.S. as an area of potentially high noncompliance with the tax laws.

First-Time Homebuyer Credit
The first-time homebuyer credit gives eligible individuals as much as $8,000 when they purchase a residence. The $8,000 refundable credit is only available for purchases between January 1, 2009 and December 1, 2009. In a taxpayer-friendly move, the IRS announced that individuals who purchase a home in 2009 may claim the $8,000 credit on their 2008 returns. If the home is purchased after April 15, 2009, a taxpayer may request an extension to file or file an amended return to claim the credit. Alternatively, they can wait to claim the credit when they file their 2009 returns in 2010. The IRS also announced liberal rules for allocating the credit among unmarried taxpayers.

President Obama’s Budget Proposals
President Obama proposed a $3.5 trillion fiscal year (FY) 2010 federal budget in February. The president proposed several tax incentives targeted to middle-income individuals, including a permanent Making Work Pay credit and a long-term alternative minimum tax (AMT) patch. Higher-income individuals, however, would pay more if Congress agrees to allow tax cuts enacted in 2001 to expire. The president has indicated that increased taxes on higher-income individuals will pay for health care reform. More details about the president’s budget proposals are expected to be released in May.

COBRA
The 2009 Recovery Act provides a special subsidy to help individuals pay for COBRA continuation coverage. Eligible individuals pay only 35 percent of their COBRA premiums and the remaining 65 percent is reimbursed to the employer or other coverage provider through a payroll tax credit. Additionally, an individual generally must have been involuntarily terminated from employment between September 1, 2008 and December 31, 2009 and fall within certain income limitations. A limited retroactive window is also available. The IRS posted information about the COBRA subsidy on its website in March and issued guidance in April.

Unemployment Benefits
Individuals receiving unemployment benefits in 2009 can exclude the first $2,400 from their incomes. The IRS reminded taxpayers about the exclusion (which, unlike other tax incentives has no income limitations) in March. The exclusion is only available for 2009. Individuals who are receiving unemployment compensation can elect to have income tax withheld. Our office can help you determine if withholding will be beneficial for you.

Broker Basis Reporting
In 2008, Congress passed the Emergency Economic Stabilization Act which, among other things, requires mandatory broker basis reporting. Brokers must report the adjusted basis of publicly-traded securities when reporting sales transactions and indicate whether gain is long-term or short-term. Reporting will be effective for stock acquired in 2011, mutual funds acquired in 2012, and other securities acquired in 2013. The IRS announced in February that it was developing guidance on broker basis reporting and requested comments from interested parties.

Automatic Enrollment
The Obama Administration is touting automatic enrollment in 401(k)s and similar plans as an effective way to encourage workers to save for retirement. In February, the IRS issued final regulations to facilitate automatic enrollment in 401(k)s, 403(b) tax sheltered annuities and 457(b) government deferred compensation plans.

Private Tax Collection
Several years ago, the IRS hired private collection agencies to handle certain collection cases. The move was immediately controversial. Supporters argued that these were cases that the IRS would otherwise not be working. Opponents argued that IRS employees and not private entities should be contacting taxpayers about their tax debts. In March, the IRS announced that it was ending the private collection initiative. The IRS collected about $70 million from the program over two years.

Ponzi Scams
Ponzi and similar scams have victimized taxpayers for years. Recently, a prominent investment advisor pleaded guilty to a massive Ponzi scheme involving securities fraud, money laundering and mail and wire fraud. The IRS released guidance in March clarifying the tax treatment of fraudulent investment scams. Among other things, the investor may be entitled to an ordinary theft loss rather than just a capital loss.

These are just some of the many federal tax developments so far this year. Please contact our office if you have any questions about these or other developments.