As we get ready for Christmas, this is a time to think about the meaning of Christmas. As a Christian, Christmas is about the birth of our Savior, Jesus Christ. As the parties wind down, and the family gatherings begin, those of you who believe that Christ was the Son of God, take time to worship and thank God for the gift of his Son to us. Merry Christmas.
Monthly Archives: December 2010
How a Tax Benefit becomes a Shelter
Joe owns a short line railroad. Joe needs to repair a bridge over the Little Stinky River. But Joe doesn’t have any money and his profitability is so low, he can’t get a bank loan. No problem. Joe is having a few stiff ones at the local bar and is sadly telling the bartender that without repairing the bridge, he’ll have to shut down his railroad. Ted Tax Lawyer is sitting at a nearby bar stool and says, “there might be a way to do this. How many miles is your railroad?” “100”, Joe answered. You need to set up an LLC and assign your track to it for a $1 for 3 years, and the bridge for 20 years. The LLC will charge the railroad a toll to cross it.” Ted asks Joe how many trips across the bridge per day and Joe says, “two, One up and one back”. “So that’s 730 trips a year? How much will it cost to fix the bridge to like new?” Joe thinks for a minute and says, “$1 Million”. “And the bridge will last for how long? Ted asks. “20 years”. “Okay so that’s 14,600 trips over the bridge for its lifetime is that correct?” Ted inquires. I guess, so, Joe answers.” Ted, pulls out his calculator, “that adds up to $69 a trip. So, you now sell shares in the LLC to investors, ” Tax Lawyer Ted replies. “But who would buy it?” Joe asks, pleadingly. “Guys who want a tax credit, now”. They can buy a share in the LLC and when the LLC spends the money on the bridge, they get up to a 50% credit which is paid back in dribs and drabs over 20 years as income. So, each share would be $7,000 since there is a cap of $3,500 per mile per year. You’ll need to take three years to repair that bridge. So, for every dollar invested they get a 50% credit on their taxes in the for each year” Tax Lawyer Ted explains. That means if a guy invests $100,000, he is creditted with having already paid $50,000 to IRS on his taxes”.
So that’s how a tax shelter works. A benefit such as this, has to be (1) Assignable; (2) spend; and (3) large enough to get someone’s attention as a credit.
Some Christmas Candy
In the new Tax Act there are a number of business incentives and what some would euphemistically call loopholes. However, these loopholes can be advantageous for some.
They continue some of these things which would have expired at the end of 2009. These include the Research Credit, Indian Employment Credit, Railroad Track maintenance credit, rapid depreciation for car race tracks, rapid depreciation for business property on an Indian Reservation, enhanced charitable deduction for donation of school book inventory, DC and Puerto Rico Investments, and extension of the 100% gain on certain small business corporation stock. Today’s loophole is tomorrow’s tax shelter. Where you see the words “accelerated” or “rapid” depreciation, that means you can invest in something and get an early write-off. The word “credit” means you get to reduce your tax by a dollar for every dollar of credit. Again, this is a great thing.
New Tax Act Changes, the GST
There is one area that folks might want to review if they have sizable estates. This is the year to make gifts to grandchildren because there is no GST tax. Thus, if there are sufficient other assets available to grandma, she might want to consider making an outright gift of $1,000,000 in Trust to the grandchildren. Such a trust could be tied up until they reach a ripe age like 40 or 50 and have had their first divorce, etc. And the Trust could grow. Assume that it is invested for growth and an annual growth rate of 5%. In 20 years that Trust would have doubled in value. In 30 years the Trust would be worth almost $4 Million (not a bad nest egg for middle age). At 10% the numbers are even more compelling. And if Grandma is worth like $100 Million, it might be the year to consider paying some 35% gift tax money to fund a generation skipping Trust. After all in two years the rates could be 55%. The trade-off is that there is no step-up in basis. On the other hand if you use cash or high basis stocks for the gift, its not too bad a deal. Additionally, if there is a trust with a life estate which has a deferred GST due to a taxable termination or distribution, 2010 is the year to end that life estate either through disclaimer or other means. We have two weeks.
New Tax Act passed
I’ve been waiting on Congress to do its job and finally some legislation has come through. There is something in the new Tax Act for everyone.
First, the highlights:
The tax benefits of the 2001, 2003 Tax Acts were extended for two years. This means that the tax rates for 2010 will hold for two more years including on capital gains. With regard to Alternative Minimum Taxes, the relief is in the Act. So, there will not be a jump in people affected by AMT next year.
With regard to Estate and Gift Taxes two huge changes.
(1) Reunification of Gift and Estate tax exemptions. Since 2001, gift tax exemption was capped at $1 Million. Now it will be the same as the estate tax exemption of $5 Million.
(2) Estate tax unified credit increased to $5 Million for years beginning in 2011. There is also a retroactive election for 2010 relating to step-up in basis. If the estate is under $5 Million, it would appear that the one can elect to step-up the basis of the assets. If its above $5 Million we’ll need to assess your personal situation to decide whether you want to pay estate tax to get a step-up in basis. The rate will stay at the current 35% rate for estates over $5 Million. There is also portability for married couples. This means that if one spouse dies after December 31, 2010 and the other dies later and the first spouse used up $3 Million of his or her credit amount, the second spouse can take up to $7 Million of the first spouse’s unused credit. Given the limited period of this law, it might be wise to look at gifts, although there is a basis trade-off if that occurs. Either way, its a huge change in the law.
These changes are only for two years. So, after December 31, 2012, the exemption amount falls back to $1 Million and estate tax rate to 55%.
With regard to the 2% payroll tax holiday for 2011, it also applies to self-employed individuals.
Energy Efficient Home Credit is extended to through 2011. Energy efficient appliances credit is extended through 2011 as well. Credits for windows, wood stoves, water heaters will continue.
Deductions for school teachers shall be continued through 2011. Sales tax deduction continued through 2012. Tax free distributions to charities from retirement plans extended through 2011.
Lots of continuation of popular business credits, research credit, and other industry specific credits.