Organizational Tax and Planning - Estate Tax - Research Paper Example

? Organizational Tax Research and Planning - E Tax and Organizational Tax Research and Planning - Estate Tax Question 1 Estate tax is the tax that is charged against any estate or inherited property receiver by descendants or legal heir. Estate tax is the same as gift tax, only that gift can be granted during the givers lifetime while estate changes hand only after the giver dies. The Internal Revenue Service (IRS) is the body charged with the administration of estate tax. In the present provisions of IRS, estate tax is taxable at a maximum rate of 35 percent and exempted up to $5,120,000. The total value of estate tax is referred to as Gross Estate, while the tax itself is estimated by taking the Fair Market Value of the total taxable estate. If the estate is associated with any Mortgage or fees payable for setting the estate, then the Gross Estate is adjusted to that amount. The Net Value of Estate, which is reduced by the value of exemptions stipulated in the Laws, is the net amount after allowing for all the possible deductions (Craig, 1995). Case advice In the current case, a wealthy couple owns a farm and a number of businesses that they would like to bestow to their three children. They would like to be advised how to minimize tax against this property, so their children can enjoy the maximum benefit. In order to effectively bequeath the property to their descendants when they die, the couple should exercise proper estate planning, and particularly focus on matters of estate tax. Looking at the provisions of Estate Tax, it appears that Estate Tax is a must pay tax that is imposed on transfer of property following the death of the transferor. While it is not possible to avoid this tax, there are a number of ways that the couple can use to evade or legally minimize the impact of this tax. The couple should ensure that they choose the most efficient method of transferring property to their descendants by minimizing estate tax. This includes use of techniques that guarantees minimization of estate tax, which will be discussed later in this paper. Question 2 The current IRS’s provision is that Estate Tax is taxable up to a maximum rate of 35% and exempted up to $120,000. When computing the amount of taxable estate amount, some specific deductions are also available, which are valid up to the end of 2013 only. Beyond this exemption, the value usually reduces to $1,000,000 while the Estate Tax increases to 55%. Some of the significant changes, which have been suggested by the US President, include increasing the tax rate to 45% and introducing an exemption of up to $3,500,000. Certainly, this proposal will not go down very well with the taxpayers and if it is implemented in its current status, it is likely to cause more harm than the benefit it is intended for. The suggestion will impose a heavy burden on the US public, and hence it is important for the congress to device ways of making estate tax provisions friendlier to the taxpayers. In this regards, different congress groups have suggested a number of proposals, which include the following. i. The Extenders group from the farming estate has suggested that the status quo should be upheld in the future, which means the tax collector should continue exempting up to $5,120,000 and imposing tax at the rate of 35%. ii. The conformers support the president’s proposal, which will reduce the amount of exemption to $3,500,000 and increase tax rate to 45%. Therefore, their wish is that this proposal is incorporated in the Estate Tax laws. iii. The Reversers group demands that the 2001/2002 tax provisions should be reinstated. This provision puts exempted amount at $1,000,000 and the Estate Tax at 55%. Ideally there are five options open to the current estate tax. These include: (i) amendment of the estate tax, (ii) passing of a compromise bill, (iii) extension of TRUIRJCA, (iv) maintaining of the status quo, and (v) implementing of the new suggestion in its current status. The best option, which would be in the best interest of the taxpayer, is to maintain the current status in regards to Estate Taxation. All the other options will certainly lead taxpayer to paying more tax to the government. Question 3 Sources have indicated that only 27% of income of wealthy households helped their children to become wealthy through inheritance (U.S. Trust & Bank of America Private Wealth Management, 2011). According to U.S. Joint Committee on Taxation, only 20% of the children from the wealthy parents will be well-off at their retirement (Kerwin & Erik, 2012). As a result, the estate tax does not really serve its purpose of promoting equity but rather makes it difficult for the wealthy to bequeath their wealth to their children. Tools available Portability Use of portability tool provides for the exemption where the first spouse died before they used it. Ideally, this provision protects those who have made errors in their estate planning or simply those who have failed to plan for their estates. This planning tool is less effective than the traditional way of crafting a well-conceived estate plan. For example, a better tax outcome can be established from the combined use of a marital deduction trust and a unified credit would result in a better tax outcome, rather than relying on portability. Furthermore, in the case of the assets that appreciate in value over time, it is better to use by-pass or unified credit trust, because they would offer better results than relying on portability. Annual Donee Exclusion This is a traditional estate and gift tax planning tool, which is not part of the tax law changes, providing for annual tax-free gifts of $14,000 in 2013. This is an increase from $13,000 in 2002, which is used to adjust for the annual inflation adjustment. This means that now the taxpayers can give up to $14,000 annually, to unlimited number of persons and still save their pay a gift or unified credit tax. However, only gifts that qualify as ‘present interest’ gifts are entitled for this exemption (Craig, 1995). Lifetime Gifts versus Transfers at Death Under the new federal tax rule the taxpayers with income above specific thresholds will be taxed a 20% rate on capital gains on appreciated assets. However, capital gains below this threshold will be taxed at 15%, which is the previous rate. These taxes falls heavily in the estate planning area especially where recipients receive lifetime gifts against gifts obtained at death. The elderly people persistently transfer real estate in an attempt to avoid probate, but unfortunately they are faced by a disastrous income tax result. Question 4 The estate owners can use several options to reduce their estate tax bill, as follows: Spending of the assets This method is used to reduce the value of an estate. However, this method is not very effective because people do not know how long they will live or the amount of money they need. As such, this option can only be reasonable if the person has accumulated a lot of wealth and they do not mind leaving nothing when they die. Giving of one’s asset to family members Since my client is willing to give away their estate, it would work very well if they can do so when they are still alive. Build a foundational estate plan In their estate plan, the couple can make use of ABC Trusts or AB Trusts, which can go a long way in reducing or even getting rid of both state and federal taxes assessed against their estates. Furthermore, the couple can use Irrevocable Life Insurance Trust (ILIT) to own and hold life insurance. This will allow the couples to benefit from life insurance owned by ILIT, which eliminates the value of the insurance profits from their taxable estate. This couple can also benefit from this since the insurance profits can offer instant cash to taxes, payrolls, and expenses (Wethor & Lofton, 2009). Having the beneficiaries get married The couple can advice the probable beneficiaries to get married in order to reduce estate taxes. From 2011, the married couple can enjoy ‘portability’ in the federal tax exemption. This means that, if one spouse of the beneficiaries dies in 2011 or later, and supposing their federal estate tax exemption is not wholly needed to evade estate taxes, then the unexploited fraction can be added to the surviving spouse's exemption. Essentially, this can allow the married couple who bequeaths the estate to pass up to $10,000,000, without being charged the federal estate taxes. In fact, if their beneficiaries are in a committed relationship but not legally married, it would be advisable for them to consider getting married so they can minimize estate taxes. Using advanced estate planning methods There are several advanced planning methods that are deliberated to trim down estate taxes and still allow the taxpayer to sustain a flow of income forever. Besides reducing estate taxes, these techniques can be used to ease the fear of running out of cash before a person dies. Both asset protection and estate tax reduction can be achieved by gifting through a Family Limited Liability Company. By creating Spousal Lifetime Access Trusts, or "SLATs”, the couple can capitalize on annual exclusion gifts and their associated lifetime gift tax exemptions. The couple can create charitable trusts such as a Charitable Remainder Trust, which can give them a charitable income tax reduction when the trust is funded. This also gives their estate a charitable estate tax deduction, when they die. The couple can also create a Qualified Personal Residence Trust, which can allow them to live in their home for a specified period, and then the home will be passed to their heirs, when the period expires, at a reduced value for gift and estate tax purposes. Moving to a new state To minimize estate tax, the couple can consider relocating from one state to another, if they live in those that collect tax on inheritance of estate. These estates include Washington, Vermont, Tennessee, Rhode Island, Pennsylvania, Oregon, North Carolina, New York, New Jersey, Nebraska, Minnesota, Massachusetts, Maryland, Maine, Kentucky, Indiana, Iowa, Hawaii, Illinois, District of Columbia, Connecticut, and Delaware. This is a very extreme method of minimizing estate tax, but it will see the couple together with their inheritors save thousands of dollars in death taxes. Question 5 In an attempt to support unlimited estate tax, the House through John Salazar (H.R. 1929) and the senate through Ken Salazar (S. 1994) have introduced a legislation creating such exemption in farms and the estate tax. However, this regulation faces hurdles because an unlimited exemption on estate tax for farmland is liable to abuse by the wealthy individuals who do not focus on farming as their core occupation. This, therefore, could lead to the government losing a lot of essential revenue or even reduce the number of family farmers. Proving an unlimited estate tax exemption for a certain type of assets provides an opportunity for wealthy people to seek ways of taking advantage of the exemption. In particular, providing an unlimited exemption on farmland encourages the wealthy people who are not farmers to convert many of their wealth into farmland, causing IRS to loss large amount of tax revenue (Craig, 1995). The Salazar bill tries to ward off these troubles through a range of anti-abuse procedures.  These provisions are deliberated to put a ceiling on the benefits of the active farmers’ farmland exemption.  Nevertheless, the procedures are not likely to be very successful at averting wealthy non-farmers from switching their assets into qualifying farmland.  For example; expert estate tax lawyers could more or less definitely find more subtle loopholes to take advantage of. Its “material participation” test is ineffective because for it to be confined to active farmers, it relies partially on a “material participation” test, a requirement that is ambiguous since it does not define material participation. Furthermore, there is no case law or regulations under IRC Section 2057 to help in addressing reservations regarding what represents material participation. The other abuse loophole is likely to emerge from the Congress’s provision for raising tax exemption to $5,000,000. This is because, ones an estate is subjected to executors, it usually acquire a strong incentive to reduce the value of assets with uncertain value, given that relatively low value is the inheritors basis in the asset – for capital gains tax revenues are usually raised. However, increasing of estate tax exemption would diminish executors’ motivation to reduce asset values, leading to a loss of income tax revenue of up to $8 billion. As such, from the perspective of revenue, the tax policy that provides for assigning basis to assets bequeathed from a deceased person is both costly and conceptually defective. Notably, where estate tax applies, executors are strongly encouraged to report assets at their lowest justifiable amounts. This kind of reporting does not only diminish the liabilities of estate tax, but also results in moderately low asset bases for their beneficiaries, defending more unrealized benefit for potential income tax collections. The transitory increase in the estate tax exemption level from $1, 000,000 to $5, 000,000, will trim down the number of estate tax returns in excess of ten times (Schmalbeck & Soled, 2011). Question 6 In the past, there has been a heated debate regarding the merits of the estate tax. However, there are several means of addressing this problem by simplifying the estate tax code while preserving the revenues the tax system generates for the government. To address this, I would recommend implementation of a new concept of an estate tax while transforming the manner in which the tax is collected. These changes will see to it that all the unproductive provisions are cleared. This will mean that all the especial provisions are edged out unless they meet the following criteria: (1) they make the tax code fairer, (2) they help the economy grow, or (3) they successfully promote other essential policy objectives. In addition, it will be essential to eradicate the complexity introduced by backup withholding, estimated tax payments, and regular withholding from estates and trusts, which are presently exposed to contradictory filing dates, procedures, and forms. Removal of this complexity can reduce the confusion caused to taxpayers and fiduciaries. In this regards, I would recommend a more efficient process in which case the fiduciaries can assign projected tax payments, including payments made with extension requests on estates Schedule K-1 appended to a well-timed filed Form 1041. What’s more, backup withholding should be treated in the same manner as regular withholding. I would also propose a “pay?as?you?go” solution whereby taxpayers making in the excess of $ 1,000,000 annually should pay their annual surcharge estate tax on their adjusted gross income. This can be done to substitute payment of tax only upon the death of the taxpayer. In one single year, the total amount of the surcharge would be enough to pay back all the current revenue from both the gift tax and the estate (Craig, 1995). Many experts have realized that the total capital gains taxes that comes from the sale of estate assets would sometimes be way above the estate taxes that would have been collected. Since the surcharge is equal to the total revenue generated from the gift tax and estate, it means that the excess capital gains tax is a one-off/windfall income to the government. It is important to assess if some of this windfall income would be reimbursed in the future, in order to cut down the amount of the surcharge. This can also be used to reduce the deficit. In view of this, I would recommend that IRS should track the assets to make sure the capital gain tax is collected. References Craig, J. (1995). Planning opportunities in postmortem estate planning. Journal of Financial Planning, 8(4), 181. Retrieved from http://search.proquest.com/docview/217543361?accountid=145382 Kerwin, K.C. & Erik, H. (2002). The Correlation of Wealth across Generations. Retrieved from http://faculty.chicagobooth.edu/erik.hurst/research/final_resub_jpe_dec2002.pdf. Kerwin, K.C., & Erik, H., (2002). The Correlation of Wealth across Generations. Retrieved from http://faculty.chicagobooth.edu/erik.hurst/research/final_resub_jpe_dec2002.pdf. Schmalbeck, R., & Soled, J.A. (2011). Estate Tax Relief and the Erosion of Capital Gains Tax Revenues. Retrieved from http://www.taxanalysts.com/www/features.nsf/Articles/ ?OpenDocument Wethor, A. M., & Lofton, D. (2009). Minimizing federal estate taxes: Advantages of an irrevocable life insurance. Life Insurance Selling, 84(1), 42-42. Retrieved from http://search.proquest.com/docview/211539586?accountid=145382 Read More