The two-year plan
One way to look at December’s extension of the Bush era tax cuts was that the price tag of this particular legislative grab-bag was guesstimated to be $858 billion. The importance of this number was that it affirms that federal legislation costing something in the $700 billion to $800 billion range, but shy of $900 billion and so a step south of $1 trillion, today is deemed to be the norm in Washington, D.C.
This legislation, which included new and renewed old tax law, drew a broad response, mainly the people’s heartfelt thanks that gridlock again had returned to the nation’s capital. This Bush-Obama bill came to be because – monstrous triangulating cave-in sellout compromise hodgepodge that it is – the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 could have been much, much worse.
But now some say it might turn out OK, even. Despite, say some, the continued uncertainty. “From a policy point of view, kicking the can another two years down the road is good for a lot of Americans’ own personal finances, but from an economic point of view it’s not going to give the relief that it needs to,” says Jon Caldara, president of the Golden-based Independence Institute, a conservative think tank. “In one way this only adds to the uncertainty of the decision-making process. ‘What will the capital gains tax be in five years when I plan on selling my business? I don’t know. Should I invest in the new factory, in the new office building? I don’t know.'”
Others look on the glass-half-full side. They say, “The passage of this bill is extremely significant. We were in 2010 in a kind of no-persons’ land where doing planning was very much curtailed because of the uncertainty,” says Theodore Z. Gelt, attorney with the Denver office of the Baker Hostetler law firm. “Although this only goes on for two years, it at least gives us two years of certainty, and the Act makes a number of profound changes that really allow us to go forward and plan for our clients. So it has had a dramatic effect.”
Financial and tax planners appear to agree on this point. “Even though it’s only two years, it’s two years. At least we can know what’s going to happen, vs. this past year, where right up until November it wasn’t clear what was going to happen,” says Wayne Farlow, founder of registered investment adviser Financial Abundance LLC.
Now that you are in a party mood, let’s look at some specifics. In summary, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 included: Temporary extension through 2012 of the “Bush-era” individual tax rate cuts, which include rate relief for ordinary income, capital gains and dividends, plus the temporary extension through 2012 of certain other “Bush-era” individual tax relief; the temporary extension through 2012 of certain “Obama-era” individual tax relief enacted in 2009; Alternative Minimum Tax (AMT) relief for 2010 and 2011; temporary estate and gift tax relief through 2012; temporary payroll tax rate reduction for 2011 of two percent on the employee portion of the Social Security tax; the temporary extension of unemployment insurance through 2011; and the temporary extension of other investment incentives and sundry expired provisions.
Needless to say, many will benefit and many will suffer from this new tax law of the land, often the same people at the same time. Expiration of the tax cuts, according to the Tax Policy Center, would have meant a married couple with two children under age 13 and a household income of about $75,000 would have paid about $2,600 more in federal income taxes in 2011.
Many observers construed not giving that $2,600 to the feds to be a good idea. Similarly, the ATM tax fix “really needed to happen, because otherwise we were going to have two million people paying about $3,000 more in tax this year and next year,” Gelt says. “People are going to be buoyed up by the Bush extension,” Gelt said. “We have some stability now for a couple of years. Things may change but people will feel more comfortable now about hiring new people and expanding their businesses.” 1}
Another part of the Bush extension, keeping the capital gains and dividends tax rates at 15 percent, “is important for getting an investment mindset, where people are going to make investments and are willing to do that because the tax rate is lower,” Gelt says. “I think there will be people who will recognize gain – instead of Like-Kind Exchanges, they will go to taxable sales of their properties, because the rates are low.”
Farlow has this advice for clients considering the sale of their business or another big asset: “Now that we have this clarity for the next two years, if you are thinking about selling your business anytime in the next several years, you might want to consider doing it in the next two years.” He reckons today’s 15 percent cap gains rates easily could go to 20 percent, noting that President Obama has said his preferred rate is 28 percent.
“So the key is, if you are going to have a big capital gain in the next few years, try to bring it into 2011 or 2012 so you won’t be paying this potential tax in 2013,” Farlow says. (Then, Farlow cautions small-business owners about the 3.8 percent Medicare tax on investment income exceeding $250,000, coming in 2013.
“Most people don’t even know about that,” he says.) Congress and President Obama promised many things, but they never promised tax simplicity. Nonetheless, the new law promises a degree of at least provisional simplicity and equity in the temporary estate and gift tax relief portion of the new law. On the estate tax side, “Especially for wealthier clients the estate tax changes were very, very profound,” Gelt says. But they were temporary, affecting tax years 2011 and 2012, during which a special $5 million estate tax exemption was created.
That’s the bad news. “The good news is that they really took a very interesting approach, where not only do you have a $5 million exclusion that covers most people, but if two people have less than $10 million you don’t even have to go to a lawyer for a fancy trust,” Farlow says. “The gift tax changed also in a very, very good way,”
Gelt adds. “What Congress did this time was to unify that exemption so that there is a $5 million generation gift tax exemption, a $5 million gift tax exemption, and a $5 million estate tax exemption, and they all work in a unified fashion: If I use a dollar of gift tax exemption, that reduces my generation-skipping tax exemption by a dollar, that reduces my estate tax exemption by a dollar.
So that now works very, very well. That is the way it should be.” Gelt overall is glad to have a year’s reduced payroll tax and the extension of unemployment insurance benefits, and believes the package adds up to change that just might spell “hope.” “Now, maybe I’m drinking the Kool-Aid, but I think this may work. I realize it is all theory but I’m pretty enthusiastic about it in its overall scheme,” he says. The tax extensions expire after the next presidential elections.
Will they be a subject of earnest debate? “There is some discussion on the table about reevaluating the entire tax system now,” Gelt says. “The last time we did that was with the Tax Reform Act of 1986. We are still living with the Internal Revenue Code of 1986, and it has been amended and amended and amended and amended and it is out of control.” Tax reform? “Not under this president and not with the divided House and Senate,” Caldara says. “I just don’t see it happening.”
Even Gelt has wearied of the proliferation of temporary tax provisions. “I would be in favor of making these changes permanent. Even if you want to make some little tinkering changes with it, if you do that, make them permanent, whatever you do. Let’s get out of this two-year cycle,” he says. According to The Wall Street Journal, as of the late 1990s fewer than a dozen tax provisions had to be renewed every year or so. As of mid-December – before passage of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 – the number had crept up to 141. The TRUIRJCA of 2010, the Journal said, was “poised to turn the whole personal income-tax system into something of a temporary structure.”
This alarms many, but Gary Hornyak sees things differently. Hornyak is vice president of Minneapolis-based Hudson Financial Solutions and in charge of its Denver office, which helps corporate clients with their accounting, finance and internal audit-related functions. Hornyak says corporate life already completely lacks certainty. How could new tax law make it any more dicey?
“Whether there is uncertainty in tax law or in legislation, there is always uncertainty in the business,” he says. “I do not think that the uncertainty in the tax legislation is going to have any greater impact on the uncertainty that already exists, and that’s kind of the key uncertainty that always exists in the tax provision.”