Tax Quote of the Week

"I guess you will have to go to jail. If that is the result of not understanding the Income Tax Law I will meet you there. We shall have a merry, merry time for all our friends will be there. It will be an intellectual center, for no one understands the Income Tax Law."



Debate Over "Cadillac" Healthcare Tax

On Jan. 6, 2010, President Obama met with two key Senators to discuss the proposed healthcare legislation. He discussed the healthcare bill with Sen. Chris Dodd (D-CT) and Sen. Max Baucus (D-MT). Sen. Dodd and Sen. Baucus have been very involved in the development of the two major bills that were combined into the Senate healthcare act.

The Senate passed the Patient Protection and Affordable Care Act (H.R. 3590) during December. Under the Senate plan, there is a 40% excise tax for "Cadillac" healthcare plans. These are defined as plans that cost over $23,000 per year for a family or $8,500 for an individual.

Rep. Joe Courtney (D-CT) has been leading the House opposition to the Cadillac healthcare tax. Rep. Courtney obtained a letter with signatures by 190 House members opposing the tax. He called on Speaker Nancy Pelosi (D-CA) to join those 190 House Members in opposing the Cadillac healthcare tax.

In the House healthcare bill, the principal funding method is a 5.4% surtax on individuals with high incomes. In a conference call with House members and former Labor Secretary Robert Reich, Rep. Courtney called for support for the surtax on high income earners. Former Secretary Reich pointed out, "In my view, there's real danger in the Senate plan that real families will be forced to cut back healthcare spending."

The 40% excise tax on Cadillac plans was initially proposed by Sen. Max Baucus. However, because of union opposition to the excise tax, Sen. John Kerry (D-MT) suggested that the excise tax be paid by the insurance companies.

Analysts have suggested two results with the "Cadillac" excise tax. First, it is probable that insurance companies will raise all rates to cover the tax on the Cadillac plans. However, if the tax on high-cost plans works as anticipated, the growth rate of insurance premiums may slow. While insurance rates will increase, the excise tax advocates suggest the rates may not grow as rapidly as they would otherwise.

Editor's Note: The concern over healthcare costs in the excise tax debate relates to wages. If healthcare costs continue to increase, employers may transfer larger percentages of future compensation into healthcare benefits and not increase wages.


IRS Fact Sheet -- 2009 Tax Credits and Deductions

In FS 2010- 4, the IRS has released a fact sheet that explains 2009 tax law changes. These deductions and credits may assist taxpayers in reducing their payments on 2009 taxes. The fact sheet focuses on deductions for college tuition, energy credits, vehicle deductions and increased limits for the standard deduction, personal exemption and alternative minimum tax exemptions.

1. American Opportunity Credit - The American Opportunity Credit provides for a 100% deduction for the first $2,000 of tuition and a 25% deduction for the next $2,000. For expenditure for tuition and qualified books, the total deduction can be $2,500. Persons with a modified adjusted gross income (MAGI) of $80,000 single or $160,000 married qualify. The credit applies to the first four years of college and is 40% refundable. Even individuals who do not pay tax may obtain a partial refund.

2. Energy Credits - There are two main energy credits. The non-business or homeowners credit is 30% of expenditures up to $5,000. The $1,500 credit may be used for improved heating and air conditioning systems, biomass stoves, and some types of energy efficient windows, doors and installation. The second residential credit is 30% with no cap on solar systems, wind turbines and geothermal heat pumps. The manufacturer must certify that the installed energy equipment qualifies for this credit.

3. New Vehicle Deduction - The state and local sales tax paid on a new car, light truck, motor home or motorcycle with a value up to $49,500 may be deducted. The vehicle must have been purchased between February 16, 2009 and December 31, 2009. Individuals qualify with incomes of $125,000 (single) or $250,000 (married).

4. Standard Deduction - The 2009 standard deduction for married couples is $11,400. Single persons qualify for $5,700 and a head of household may receive $8,350 as the standard deduction. With the higher standard deduction rates, the majority of taxpayers no longer itemize.

5. Alternative Minimum Tax - The AMT exemptions were increased for 2009 to $70,950 (married), $46,700 (single) and $35,475 (married filing separately).

6. Personal Exemptions - The personal exemption will be $3,650. This exemption is available for the taxpayer and for eligible dependents.


Estate Tax Retroactivity?

Prior to leaving Washington in December, the House of Representatives passed an estate tax freeze. The House plan would freeze the estate exemption at $3.5 million and the estate tax rate at 45%.

However, the Senate was unable to come to a compromise. By December, the Democratic proposal was to accept the House estate tax freeze, while the Republicans generally were supporting an exemption of $5 million and an estate tax rate of 35%.

If Congress does not act during 2010, then the estate and generation skipping transfer tax will be repealed for 2010 and will be restored on January 1, 2011. At that time there will be a $1 million estate exemption (as indexed for inflation) and a 55% estate rate.

Speculation among the estate planning bar now centers on whether the Senate will be able to pass an estate tax bill during 2010 and whether that bill will be retroactive.

It appears to be difficult for the Senate to act quickly on estate taxes. While Senate Finance Chair Max Baucus (D-MT) has indicated that he would like to proceed, the rules of the Senate and politics of an election year make progress very difficult.

Under the Senate rules, passing a controversial bill requires 60 votes. While there are 60 Democratic Senators, several are facing difficult elections and are not willing to vote for a freeze, or perhaps even a compromise. If a Senator facing a difficult re-election campaign votes for a freeze or compromise, his or her opponent will be likely to advocate repeal of the tax and gain votes.

In election years, the Senate normally acts by June. During the fall, those Senators who are running in competitive races are very reluctant to face controversial issues. For this reason, it is quite possible that the Senate will miss the May-June window for legislation and will then need to address the estate tax issue in a "lame duck" session. Therefore, the estate tax compromise legislation may not be completed until December 2010.

If legislation is deferred until late in 2010, will it be constitutional? The lead case approving retroactive taxation is United States v. Carlton, 512 U.S. 26 (1994). Mr. Carlton was the executor for Mrs. Day, who was an heiress from the Keck family. Carlton discovered that the Sec. 2057 estate tax deduction for half of the sale value of securities to an ESOP did not require ownership on date of death. He purchased MCI shares for $10.7 million and sold them to the MCI ESOP. Carlton then claimed an estate deduction of $5.3 million.

Congress recognized the obvious problem in the law and amended Sec. 2057 retroactively to close that loophole.

On an appeal to the Supreme Court, the retroactive tax legislation was upheld. The court determined that retroactive tax legislation can be "rationally related to a legitimate legislative interest." The retroactive tax legislation is permissible if it is enacted to correct an error or mistake in tax code, there is a reasonably short time and there is notice or reasonable expectation on the part of the taxpayer that the change could be made.

Editor's Note: With the current political structure and the rules in the Senate, it is very possible that an estate tax compromise will occur after the fall election. While a retroactive compromise will certainly be challenged in court, the probability is that the U.S. Supreme Court will uphold that law. Particularly if the compromise is to extend the 2009 estate tax law, it would not be a new tax, would probably be deemed enacted within a reasonable time because IRS Form 706 Estate Tax Returns for 2010 decedents will not be filed until April of 2011, and there is certainly debate on this issue that gives a measure of notice to estate planning attorneys and their clients.


Applicable Federal Rate of 3.0% for January -- Rev. Rul. 2010-1; 2010-2 IRB 1 (21 Dec. 2009)

The IRS has announced the Applicable Federal Rate (AFR) for January of 2010. The AFR under Sec. 7520 for the month of January will be 3.0%. The rates for December of 3.2% or November of 3.2% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2010, pooled income funds in existence less than three tax years must use a 4.6% deemed rate of return. Federal rates are available at clicking here.