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IRS Announces Cost of Living Adjustments

The Internal Revenue Service announced cost of living adjustments affecting dollar limitations for pension plans and other tax benefits for Tax Year 2012.  The highlights include: 

  • 401(k), 403(b) and most 457 plans elective deferral increased from $16,500 to $17,000 (Catch-up contribution limit for those aged 50 and over remains unchanged at $5,500) 
  • Defined benefit plan limitation increased from $195,000 to $200,000 
  • Limitation for defined contribution plans increased from $49,000 to $50,000 
  • The definition of a highly compensated employee is increased from $110,000 to $115,000 
  • The definition of a key employee in a top-heavy employee benefit plan is increased from $160,000 to $165,000 in compensation
  • Personal and dependent exemption increased from $3,700 to $3,800 
  • Standard deduction for married filing a joint return increased from $11,600 to $11,900 
  • Standard deduction for singles and married filing separately increased from $5,800 to $5,950 
  • Standard deduction for heads of household increased from $8,500 to $8,700 
  • The foreign earned income deduction increased from $92,900 to $95,100 
  • Exclusion from estate tax amount increased from $5,000,000 to $5,120,000 (The annual exclusion for gifts remains unchanged at $13,000) 
  • Standard Continental United States  per diem rate increased to $123 ($77 lodging, $46 meals and incidental expenses) 

New business, medical and charity mileage rates have not been released as of this writing.

Estate Tax Reinstated

The 2010 Tax Relief Act reinstated the estate tax for deaths on or after January 1, 2010, and before January 1, 2013. Under this new law, the maximum estate tax rate is 35%, with an exclusion amount of $5 million.

 The executors of decedents who passed away in 2010 may elect the reinstated estate tax option or the no estate tax, carryover basis / limited step-up basis provisions.

 For estates under $5 million in taxable value, executors will probably choose the estate tax option with a $5 million applicable exclusion and the full step-up in basis.  These estates will pay no estate tax and the heirs will inherit the assets at fair market value. 

For very large estates, the election to apply the no estate tax and carryover basis provisions as if the 2010 Tax Relief Act was never enacted will probably render the most savings.  These large estates will not pay estate tax but will have a step-up basis limited to $1.3 million for non-spouse heirs, and an additional $3 million for surviving spouses.

For mid-sized estates (estates between $5 million and $10 million) the analysis will be more complicated.  Executors will need to take into account many factors to determine whether it is better to pay estate tax in 2010 or inherit most assets with carryover basis. 

See your tax professional if you have lost a loved one in 2010.

Delayed Filing Season for Individual Tax Returns

The IRS has announced that it will not be ready to start processing tax returns impacted by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 until mid to late February.  The delay affects paper and electronic filers.  The IRS will announce when it will start processing tax returns impacted by the late tax law changes.

The delayed filing deadline applies to anyone who itemizes deductions on Schedule A, and to anyone who takes higher education tuition and fees deductions and educator expenses.  In the meantime, taxpayers should compile their information, start working on their tax returns or visit their tax preparers.  But… they should wait to file until the IRS announces it is ready to start processing returns!

Effects of the repeal of estate tax for 2010

For taxpayers who die in 2010, when estate tax has been completely repealed, the basis of property acquired from a decedent will be the lesser of:

1)      Adjusted basis of the property in the hands of the decedent immediately prior to death.

2)      Fair market value as of the date of death, or

Each estate will receive $1,300,000 of basis step-up adjustment that can be applied to assets selected by the executor. 

In addition to the $1,300,000 basis step-up, there will be additional increases in asset value in an amount equal to the sum of the following:

1)      The decedents unused capital loss carry forward

2)      The decedents unused net operating loss carry forward

3)      Passive activity losses unused as of date of death

In addition to the above mentioned increases, the estate is entitled to another $3,000,000 of basis step-up for transfers to the surviving spouse.

The Internal Revenue Service is designing Form 8939 “Allocation of Increase in Basis for Property Received from a Decedent” to report the transfers of property taking place in 2010.  Form 8939 is not available yet, but it must be filed with the decedent’s final income tax return for 2010.

Here are 2 illustrations:

John, a single man, dies in with the following estate:

FMV (Fair Market Value)                              $ 8,000,000

Decedent’s Basis                                            2,000,000

Heir’s carryover Basis                                     2,000,000

Plus step-up                                                    1,300,000

Heir’s total basis                                            $ 3,300,000 

If heirs were to sell the assets right away, they will incur a gain of $4,700,000 (difference of 8,000,000 – 3,300,000). 

Joe, a married man, dies in 2010 with the following estate: 

FMV (Fair Market Value)                              $ 8,000,000

Decedent’s Basis                                            2,000,000

Plus spousal step up                                       3,000,000

Plus step-up                                                    1,300,000

Spouse’s total basis                                      $ 6,300,000

If spouse were to sell the assets in 2010 she will incur a gain of $1,700,000 (difference of 8,000,000 – 6,300,000).

These are simplified illustrations but when preparing the actual form 8939, you will need to allocate the step up in basis to the specific inherited assets.  See your tax professional to find out how this may affect you if you’ve lost a loved one in 2010.

Extensions: Are you in denial or are you a procrastinator?

You filed for an extension of your individual tax return in the spring but now it is time to face the task that you have been avoiding.  I am talking about getting those taxes done!  I know it is only July and the return is extended until October but the longer you wait the harder it will be to get started.

Here are some pointers to get you motivated whether you are preparing the return yourself or you are hiring a professional tax preparer.

1)      Start with your prior year tax return as a reference point.  Pull that 2008 tax return out of the filing cabinet and all the supporting documents.  Then pull out of the cabinet the file labeled “2009 taxes” and compare the 2009 to the 2008 documentation to compose an open item/missing list. 

2)       Don’t panic if you are missing several items!  It is easy to get a lot of the information on line.  Let’s say you are missing Form 1098 Home Mortgage Interest.  Most mortgage companies have that information available on line.

3)      Set a deadline to acquire all the missing information no later than August 15th.

4)      Now think about any changes that took place in your life during 2009.  Do you have a new dependent in your family?  Did you start a new job?  Did you acquire a new rental property? Did you move?  These new situations may have tax implications so you should gather all the pertinent information and do some research or bring this new information to your tax appointment.

No more excuses…You have gathered all the information so it is time to tackle the tax return yourself or visit your tax preparer.  Do not wait until October 12th to get started!!!  You will not be able to file a complete and accurate tax return at that point.  Also you will probably miss deductions and tax credits.  And last but not least, if you are hiring a professional tax preparer, remember that he can only do a good job if you give him all the information and enough time to evaluate your situation and process your tax return.

Did your parents name you trustee of their trust?

 If the answer is yes, you are probably the responsible and trustworthy one in the family.  Do you get along with your siblings? “Yes, of course”. Even if you do, you should consider preparing a trust accounting when the time to assume your fiduciary duties comes. “Why?”you may ask… “My siblings and I get along really well and they trust me…” Well, after a little more than 20 years as a CPA working in trust/ estate taxation, I could tell you some interesting stories that would make many soap operas look like Disney shows!

You may face questions from your siblings like: “When dad died five years ago the trust was funded with $2,000,000, how come we only have $800,000 now?”  That would be pretty hard to answer without a complete trust accounting.  One of the partners of our firm participated as an expert witness in a case involving a family with a trust where no fiduciary accounting was ever done.  The case lasted over a year and the legal and court fees exceeded $250,000 and tore the family apart.  If fiduciary accounting reports had been prepared since the inception of the trust, the litigation would have been avoided and the family would have saved a lot of money.  Professional fees for preparation of fiduciary accounting reports would have cost them less than 10% of the legal and court fees, not to mention, maybe save their relationships.

I would recommend preparing a trust accounting in 100% of the cases, unless all the beneficiaries specifically waive it in writing. Trust account is different from regular accounting because special accounting principles apply to trusts.

See a professional for advice!

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