POST ELECTION TAX PLANNING
By David Keligian, The Busch Firm
The combination of Barack Obama's election victory, the current economic climate, and California's fiscal crisis have troubled many. This letter contains my comments on the potential impact and the immediate steps you can take now (listed on page 3) to help protect your family's income and assets.
- FEDERAL INCOME TAXES. There is no question taxes are going up. Despite the vagueness of President-elect Obama's proposals, anyone with an income of $250,000 or more can expect a significant tax increase. This will occur as a result of increases in top tax rates, "hidden increases" accomplished by increased phasing out and disallowance of exemptions and deductions, increased payroll taxes, and regulatory action that will increase taxes.
The Housing Assistance Tax Act of 2008 and the Emergency Economic Stabilization Act of 2008 contained a host of complicated tax incentives, and given Congress' propensity to try and effectuate social engineering through the tax code, I anticipate many more such provisions in the coming months.
In matters like these, "the devil is in the details." For the most part, all of the new tax breaks are targeted to very specific areas that will most likely not have broad application to most taxpayers. For example, there are new tax benefits for alternative energy production, low income housing, and more liberalized rules for write offs in disaster-related situations. These provisions will be meaningless to most California taxpayers.
Even before the current financial crunch that has triggered massive federal spending, Congress was putting strong pressure on the IRS to close the "tax gap" - the difference between what the IRS estimates taxpayers owe and what they pay. In part, that "gap" will be closed by more aggressive IRS audit and enforcement actions and (my guess) an increase in IRS audits.
All of this means you must pay closer attention to your tax planning in the coming months to be alert to opportunities to save taxes and minimize the impact of increases.
- CALIFORNIA TAXES. California's fiscal crisis has been brought about by a lack of political discipline, a dysfunctional budget system, and politicians who always rely on raising taxes rather than cutting spending. However, I have heard from sources within the Governor's office that Governor Schwarzenegger is serious about his proposal to raise sales taxes to an unprecedented level.
The Governor's primary concern is that his failure to take steps to increase California's tax revenues very soon will adversely affect California's bond rating, which would add to the State's fiscal problems by greatly increasing the state's borrowing costs. In addition, the Governor is concerned that if he does not push a plan for a tax increase, the legislature's response will be even more draconian.
Putting aside the issue of whether it makes sense to further burden California businesses which are already struggling with a weak consumer market (a good example - car dealers), the real question to me is whether California's legislature will push to also increase income taxes, either directly or through new phase outs, restrictions on the ability of taxpayers to use losses, and other "hidden" tax increases. Again, close attention to developments is warranted.
- ESTATE TAXES. If it wasn't clear before, it certainly is now - estate taxes are not going to be eliminated or reduced in the foreseeable future. President-elect Obama has stated that he favors an estate tax exemption of $3.5 million per person and a 45% tax rate. What is not clear is whether the gift tax exemption will be increased from the present $1 million to $3.5 million as well.
If the gift tax exemption is increased, it will present the opportunity for significant savings. If the gift tax exemption remains at only $1 million, it will be evidence of Congress' intent to try to increase estate taxes on larger estates through other means.
Since most estates would avoid tax with a $3.5 million exception, there is the risk Congress will make other estate tax changes at the same time it increases the exemptions. Possibilities include eliminating discounts, and/or changing other rules that might eliminate the most effective types of estate planning. This approach allows Congress to significantly increase estate taxes on larger estates while simultaneously claiming they reduce them.
- REGULATORY ENVIRONMENT. California is already more hostile to businesses and business owners than most other states. When you combine this with an activist president and one party control of our federal government, my expectation is there will be new laws and regulations which expose businesses to additional potential liabilities.
These liabilities may not necessarily be restricted to the effect of governmental rules. They could take the form of new laws granting expanded "rights" which make it easier for potential plaintiffs to sue businesses. The chances for significant tort reform and prevention of other abuses of the legal system have certainly been lessened for the foreseeable future.
When you combine this with a depressed economic climate, one can predict a greater propensity for lawsuits against businesses by i) new classes of plaintiffs that the government has decided need more protection, and ii) plaintiffs looking for a deep pocket.
- STEPS TO CONSIDER TAKING NOW
- Estate PlanningYou should seriously consider transferring income-producing assets to your children or grandchildren now. Doing so has the following benefits:
- Low Asset Valuations. The current economic climate has lowered valuations on many asset classes, meaning it is easier to transfer these assets and get them to your children and grandchildren at additional estate tax savings.
- Interest Rates. The interest rates the IRS requires you to use for certain transfers of assets is at a very low level, further increasing your savings if you act now.
- Prospect of Inflation and High Rates. If you consider the amounts of money the government is printing to finance all of the various bailouts we keep reading about on a daily basis, it is likely we will experience higher future inflation and interest rates. Both will make it much more expensive to transfer assets if you wait.
- Asset Protection. You should revisit your current business operations and holdings to determine if relatively simple steps to better protect your assets from claims are available to you.
Such steps can include separating an operating business into two or three separate legal entities, or owning valuable assets like real estate and intellectual property in a separate entity instead of operating entities. You can achieve both asset protection and estate tax savings by transferring "safe" assets to trusts for your children or grandchildren.
Bear in mind that the benefit of such planning is not simply to protect you from lawsuits, but also to give you the option of being able to discontinue businesses with less exposure to lenders, landlords, or government agencies.
- Income Taxes. As new tax incentives are enacted, we will identify those with potential application to your situation. Their highly specific nature means you must be more alert than usual to take advantage of the savings.
- CONCLUSION. The current political and economic climate is no reason to panic. However, it does increase the challenges of creating and preserving wealth. Unlike past years, I do not believe there is any prospect of impending changes to the estate tax law that make waiting a good bet.
As noted above, interest rates and valuations are already very low. The danger in waiting longer to act is that as the reality of all of this extra deficit spending sinks in, politicians can be expected to try and raise revenue by further increasing taxes. Even though estate taxes represent a relatively small proportion of the total federal budget, my own feeling is that it will be very easy for politicians to justify increasing taxes on large estates by eliminating the most powerful planning strategies.
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