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What the Tax Relief and Job Creation Act
Means for You

On December 17th, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Authorization & Jobs Creation Act of 2010 (“The 2010 Tax Act”). The Tax Act has immediate, wide-ranging implications to individuals, businesses and estates. While this legislation does provide clarity - and opportunities - for the next 2 tax years, the tax landscape beyond 2012 remains unsettled. This newsletter examines several of the key provisions of the new law.

Income Tax

The 2010 Tax Act extends the 2001 ordinary income tax rates for individuals that were set to expire at the end of 2010 for all income levels. The Tax Act also extends the 15% top rate for long-term capital gains and qualified dividends that has been in place since 2003. Below is a graph that illustrates the tax bracket, long-term capital gains and dividend rates extended by the Act. In addition, you will see what happens in 2013 if this Act is allowed to “sunset” without amendment or extension.

Year	Highest Fed. Income Tax Bracket	Highest Long-Term Capital Gains Rate	Highest Qualified Dividend Rate	Phase-out of Itemized Deductions & Personal Exemptions
2010	35%	15%	15%	No
2011-2012	35%	15%	15%	No
2013	39.6%	20%	39.6%	Yes

This chart shows both long-term capital gains and qualified dividends at the highest possible tax bracket. For taxpayers whose taxable income does not exceed the 15% tax bracket ($34,500 for single filers/$69,000 for married filers), the tax rate for long-term capital gains and qualified dividends was extended to be 0% for the next 2 years. This will continue to warrant consideration of gifting appreciated assets from those in higher tax brackets to those at or below the 15% tax bracket.

The new law, however, is more than just an extension of previous income tax rates. Among the myriad of provisions, we highlight below the one year payroll tax cut, a “patch” for the Alternative Minimum Tax (AMT), benefits for direct gifts from IRAs to charities, and bonus depreciation and expensing options for businesses.

• The Making Work Pay tax credit has expired and a Social Security tax reduction of 2% (6.2% down to 4.2%) on the first $106,800 of income has been granted to employees in 2011. This is expected to inject over $100 billion into the economy as employees earning up to or over $106,800 will receive a tax benefit of over $2,100.
• The AMT “patch” increases the AMT exemption amount for single filers to $48,450 and $74,450 for married filers for both 2010 and 2011. This move will save an estimated 20 million taxpayers from AMT but was only updated for 2010 and 2011 and will once again need to be addressed for the 2012 tax year and beyond.
• We also have the return of the "direct to charity" distribution option for some Individual Retirement Accounts. For IRA owners subject to required minimum distributions (RMDs), up to $100,000 can be transferred directly from an IRA to a charity and avoid being reportable as income on the IRA owner's tax return. The provision can benefit potential donors in several ways. One is administratively - it is technically more efficient to gift directly to a charity from an IRA than to recognize the income and offset with a deduction on the tax return. Secondly, for donors who give generously and would be subject to limitations on charitable deductions, this allows additional giving without losing the deductions related to non-IRA donations. Lastly, for those IRA owners who have non-deductible contributions in their IRAs, this direct to charity distribution is not treated with the same pro-rata formula imposed on standard distributions. In an IRA which has some cost basis, a distribution to a charity is deemed to come only from the taxable portion of that IRA, thus increasing the percentage of the IRA that is not taxed in the future.
• For businesses, 100% bonus depreciation is available for qualified property placed in service between Sept 8, 2010 and up to December 31, 20
• Businesses may also expense under Sec. 179 up to $500,000 with an investment limit of $2,000,000 for both 2010 and 2011. For 2012, these limits fall back to $125,000 for the expense limit and $500,000 for the investment limit.

Roth Conversion Update

For those electing to convert Traditional IRA or Qualified Plan assets in 2010 to a Roth IRA, consider taking advantage of the extension of lower income rates by spreading the taxable income from the conversion over the 2011 and 2012 tax years. The ability to convert to a Roth IRA still exists in 2011 and beyond but you now are required to recognize the taxable income in the year of conversion.

Estate and Gift Tax

Some of the most significant opportunities resulting from The 2010 Tax Relief Act are in the areas of gift and estate planning. To reset where we were prior the new legislation, both the estate and generation-skipping tax (GST) exemptions and tax rate had been scheduled to revert in 2011 to their pre-2002 levels of $1,000,000 and 55% respectively. The 2010 Tax Relief Act, at least for 2011 and 2012, increases the estate, gift and GST tax exemptions to $5,000,000 and reduces the rate to 35%.

Gift Tax: For gifts made after 2010, the gift tax is reunified with the estate tax with a combined exemption of $5,000,000 and a top tax rate of 35%. Donors of lifetime gifts will continue to be able to use the annual gift tax exclusion before application of their $5,000,000 lifetime exemption. For 2011, the inflation-adjusted annual exclusion amount is again $13,000 per donee and married couples may continue to “split” their gift and make combined gifts of $26,000 to each donee.

GST: With the increased exemption for both gift and GST taxes, here is an example of a GST tax planning opportunity over the next 2 years:

In 2011 or 2012, an individual could give up to $5,000,000 (assuming none of his or her lifetime gift tax exemption or GST tax exemption had been used previously) to a “Dynasty Trust” for the benefit of all of his or her descendants. No gift tax would be due on the transfer. If the trust is governed by Missouri Law (which no longer limits how long a trust may last), the trust will not be required to terminate at any date in the future and conceivably could last as long as the individual has living descendants. Distributions from the trust would not be subject to estate, gift or GST tax even if the distributions are made to the individual’s grandchildren and more remote descendants.

Portability: A new concept introduced by the 2010 Tax Relief Act allows for the portability or transfer of the estate tax exemption between spouses, thus truly providing for a combined estate tax exemption amount of $10,000,000 for a couple. If a spouse dies during 2011 or 2012, any portion of the estate tax exemption remaining unused by the deceased spouse’s estate may be used by the surviving spouse in addition to the surviving spouse’s own exemption amount. To take advantage of this portability, the executor of the first deceased spouse’s estate must make an election on a timely filed federal estate tax return (regardless of the value of the estate of the first deceased spouse). This concept of portability does not, however, extend to the generation-skipping tax exemption.

Credit Shelter Trust (CST): Many estate planning documents call for the use of a Credit Shelter Trust at the death of the first spouse in order to ‘capture’ their estate tax exemption. Although these new laws and particularly portability may appear to eliminate the need for an individual to use a CST or to re-title assets so that each spouse has approximately equal estates, in analyzing this provision we conclude that may not necessarily be the case. Utilizing a credit shelter trust at the death of the first spouse to die would still exclude the subsequent appreciation in those assets from the gross estate of the second spouse to die. Sheltering that appreciation from taxation in the estate of the second spouse to die would in many cases justify utilization of a CST at the death of the first spouse. Re-titling of assets to equalize the estates of spouses is still a good idea.

Grantor Retained Annuity Trusts (GRATs): The new legislation does not address the proposed changes to the GRAT rules and the valuation rules that have been the subject of prior tax change proposals for intra-family transactions. Accordingly, it appears that GRATs and Family Limited Partnerships, as we know them, will continue to be available as planning strategies at least for 2011 and 2012.

Life Insurance: It may seem unnecessary now for those with less than a $5,000,000 estate who set up a irrevocable life insurance trust for the primary purpose of providing cash to pay estate tax to keep the policy. However, you may want to keep the policy because if Congress does nothing over the next two years, the exemption will go back to $1,000,000 in 2013 and the estate tax rate goes back to 55%.

2010 Estates: For those that died in 2010, their estates have an opportunity to take advantage of no estate tax and limited step-up in basis ($1,300,000 million for assets and an additional $3,000,000 to assets transferred to a spouse) OR to use the 2011 exemption amount of $5,000,000 and get a full step-up in basis. This is a complicated matter we recommend discussing with your tax or legal professional.

Estate Tax Summation: The increased estate and gift tax exemption and GST tax exemption, combined with their respective rate reductions, should cause everyone to review their current estate plans as well as consider the potentially significant planning opportunities in 2011 and 2012. For those with a net worth in excess of $10,000,000 we suggest speaking to Commerce Bank Financial Planner to discuss potentially advantageous planning opportunities.

The provisions of the 2010 Tax Relief Act are subject to the sunset provisions of the 2001 tax act. Consequently, without further Congressional action, as of January 1, 2013, the estate and gift tax exemption and the GST tax exemption will revert to $1,000,000 per person with each tax subject to a top rate of 55%. As a result, it seems likely that the estate, gift and GST taxes will be revisited prior to 2013. However, we should also mention that under the new law both the GST tax exemption and estate tax exemption are inflation indexed beginning in 2012 which suggests there may be some expectation by Congress that the $5,000,000 exemption amount will be extended after 2012.