NEW YORK — Now is a good time to give stock to family members who can hold onto the gift until the shares are worth more. A parent or grandparent can give away more for less.

Federal gift and income taxes should get serious thought, though, before choosing which shares to give or how to give them. Taxes may make it smarter to sell a stock and give the cash instead, or to set up a trust to hold the shares.

It is especially important now, when many stocks have lost value, to weigh the tax consequences of giving.

Many people who make gifts ignore taxes until they sit down with an accountant at the end of the year, says Stefan F. Tucker, a partner in the Washington, D.C., office at Venable LLP. Instead, clients should “think about taxes early and often.”

The key is to analyze the interplay between gift, estate and income taxes, according to Tucker.

Federal gift tax rules currently let an individual give an unlimited number of gifts up to $13,000 ($26,000 for couples) per recipient, free of gift tax.

Separate from the $13,000 gifts, each person can give away up to $1 million free of gift tax during a lifetime. This may be a good time to use up some of that lifetime exemption, according to estate planners.

When is it smarter to sell shares and give the cash instead? Often, it’s when the stock has lost value since the owner bought it. The idea is for the donor to take a tax loss rather than passing shares to someone who can’t use it at all.

When shares are sold at a loss, the tax cost is the lower of the donor’s tax cost or the value at the time of the gift. So, if shares cost $100,000 but are worth $50,000 at the time of the gift and are later sold by the recipient for $50,000, no loss can be taken.

The donor can benefit by taking the loss. Here’s an example provided by Tucker: A man gives $50,000 from the sale of stock that he bought at $100,000 to his daughter and takes a capital loss of $50,000; the loss yields a federal income tax savings of $7,500 (15% — the current top capital gains rate — times $50,000) when used to offset a capital gain.

This leaves $7,500 in the man’s pocket after he gives away the $50,000. If the man and his daughter decide the sold stock is a good long-term investment, they can buy more. The amount of the gift over $13,000 would go against the man’s $1 million lifetime exemption.

Understanding how cost basis works is important in figuring out the tax aspects of a gift of stock.

The person who gets a gift of stock gets the donor’s cost basis in the shares. (The exception is when the gift is big enough to generate gift tax; then, a portion of the gift tax is factored into the new cost basis.)

The donor also passes his or her holding period for the shares along. So, if he or she held it for 36 months, the recipient is also considered to have held it that long.

The idea of gifting while stocks are priced cheaply is generally for the recipient to hold the stock and get the gains. Current low capital gains tax rates can benefit a family member who ends up selling a gift soon, however.

Rande Spiegelman, vice president of financial planning at the Schwab Center for Financial Research notes that a person who sells a gift of stock soon after receiving it could end up paying tax at a much lower rate (as low as 0%, depending on the bracket) than the donor would owe.

Many wealthy people set up special trusts to reduce the tax hit on gifts. A common vehicle for this is the grantor trust for income tax purposes.

The donor gives stock to the trust, and pays all the income tax on income it generates. This way, the property given to the trust isn’t diminished by taxes paid when the stock is sold.

A parent who just wants to make a $13,000 gift to a child would probably not bother with the trust for a single gift of that size, says Dan Schrauth, a wealth adviser in the San Francisco office at J.P. Morgan Private Bank.

However, setting up a trust isn’t particularly complicated or expensive, so it can pay to have one to receive gifts of stock over the years, says Schrauth.

By Arden Dale
A DOW JONES NEWSWIRES COLUMN

President Obama’s budget proposes to hike the marginal tax rates of the wealthy to 36% and 39.6% beginning in fiscal 2011, and to increase by 5% the capital gains and dividends tax rate for the wealthy - tax changes that market participants say could lead to higher demand for tax-exempt bonds.

“The Obama tax hike [on the marginal rates] would mean that muni investors could buy bonds about 40 basis points richer in yield to achieve the same after-tax yield,” said Matt Fabian, a managing director at Municipal Market Advisors.

Wealthy would be defined as married couples earning over $250,000 and individuals earning $200,000 or more.

However, the administration has abandoned a proposal aired in a budget outline released in February that would have capped the amount of deductions taxpayers could take at 28%, another move that may have pushed wealthier investors into the muni market.

The most recent budget document also shows an even smaller estimate for how much the federal government will pay for the new Build America Bonds program than a document released Thursday.

However, market participants said the discrepancy does not really matter since the higher numbers were already underestimating the amount of payments that will be made under the program.

In an appendix to the budget released last week, the administration estimated that the Treasury Department would spend $91 million in fiscal 2009 and $340 million in fiscal 2010 on BABs, which it said included Recovery Zone Economic Development Bonds

But the Analytical Perspectives document released yesterday estimated just $50 million and $192 million for BABs during those years. Neither administration officials nor market participants could explain the differences in the estimates.

Treasury officials say roughly $9 billion of BABs have been issued during the past two months since the program started. Clifford Gannett, the director of the Internal Revenue Service’s tax-exempt bond office, which is charged with processing the direct payments for those bonds, said Friday that doing “very conservative” math on those numbers indicates $90 million of payments on just those issuances.

It is possible that the budget numbers stem from revenue estimates put together when the BAB legislation was being drafted, well before anyone knew how popular they would become, sources said.

The BAB program, created by the stimulus law, allows governmental issuers to sell an unlimited amount of taxable debt and either receive a cash payment from the federal government or provide investors with a tax credit equal to 35% of the interest rate.

The Recovery Zone Bonds, $10 billion of which were authorized under the stimulus law, also would provide issuers with a cash subsidy, but that payment is equal to 45% of the interest rate, and there is no option to provide a tax credit to investors. The bonds are to be allocated to areas hit hard by unemployment in 2008.

The budget documents also provide some fresh details for the administration’s estimated savings of phasing out the Federal Family Education Loan student loan program and moving to a system in which all federally guaranteed student loans are originated directly by the Department of Education. Many state-level FFEL lenders, who are opposed to the switch, issue municipal bonds backed by their student loans.

By ending “subsidies” paid to FFEL lenders, the budget documents estimate savings of $24 billion over five years and $48 billion over 10 years.

But an appendix to the budget proposal shows that the federal government has historically overestimated the costs of subsidies for FFEL while underestimating the costs of the direct loan program.

For the roughly $811.7 billion of FFEL loans originated since 1992, the cost of each loan averaged about 8.2 cents per dollar, compared to original estimates of about 10 cents. Issuance costs for the roughly $249.8 billion of direct loans were about 4.5 cents for each dollar loaned, compared to estimates of about 0.6 cents.

Almost three quarters of the budget’s proposed $100.5 billion of grants to state and local governments would be used for transportation infrastructure, mostly highways.

The budget proposed some modest changes to transportation and infrastructure funding, including a new user fee that would fund the air traffic control system beginning in 2011.

The administration argued that the current excise tax that is levied on users based mostly on airline ticket prices should be replaced by a tax related to the cost of services provided by the Federal Aviation Administration. If such a measure is taken, it will generate $9.6 billion in 2011 and existing aviation excise taxes could be reduced, according to the budget.

The administration also confirmed in its budget that it hopes Congress will create a national infrastructure bank and fund it at $5 billion in fiscal 2010. However, only a portion of that would be spent in 2010, the budget said.

The budget estimated that the federal government will provide $73.4 billion of transportation in grants to state and local governments in fiscal 2010, up about $11 billion from this fiscal year. Federal transportation grants would reach $102.3 billion in fiscal 2019 under current policy, according to budget documents.

The administration also proposes a five-year, $5 billion high-speed rail state grant program that would add on to the stimulus funding provided for high-speed rail development.

In addition, the budget includes $3.9 billion for the clean and drinking water state revolving funds.

By Peter Schroeder, Audrey Dutton and Andrew Ackerman, Bond Buyer
May 12, 2009

NEW YORK — Cracking into retirement savings early is the tax equivalent of standing on a street corner burning $10 bills.

Hard times have more people doing it anyway.

Early withdrawals from Individual Retirement Accounts and 401(k) plans trigger taxes and penalties that can really add up. There are exceptions, but only for some people who use the money to buy a first home, or pay for higher education or other items.

Many people have at least a vague understanding of all this, but that isn’t stopping them.

The number of companies reporting early withdrawals for hardship from 401(k) and 403(b) plans (the non-profit version of 401(k)s) rose from 15% in October 2008 to 44% last month, according to a recent Watson Wyatt study that polled executives at 141 U.S.-based companies using an online questionnaire.

Many more clients than usual asked about early withdrawals from retirement savings this tax season, according to Michael Eisenberg, a certified public accountant at Eisenberg Financial Advisers in Los Angeles, who is a member of the AICPA’s Financial Literacy Commission.

Eisenberg advises strongly against early withdrawals; none of his clients ended up taking money out, he says.

The federal tax penalty for taking money out of a 401(k) or IRA before age 59 1/2 is 10% of the amount of the distribution. That levy goes on top of any tax owed on the amount. State taxes and penalties may also apply, and they vary.

So, an early withdrawal of $1,000 from a 401(k) or IRA would generate tax on that amount, plus a federal penalty of $100, plus possible state taxes and penalties.

There are exceptions that allow penalty-free early withdrawals from retirement savings, though they differ depending on whether it’s an IRA or 401(k).

For IRAs, the taxpayer may be able to avoid a penalty (but not tax) if he or she uses the money for one of several reasons, including:

*To buy a home (if qualified as a first-time homebuyer under IRS rules).

*To pay for higher education for the immediate family.

*To pay for unreimbursed medical expenses over 7.5% of adjusted gross income.

*To pay for health insurance if the taxpayer has been unemployed for a certain period.

For 401(k)s, the taxpayer can make an early withdrawal without a penalty in several cases, including if he or she:

*Leaves the employer in the year he or she turns 55 or older.

*Uses the money to pay unreimbursed medical expenses over 7.5% of adjusted gross income.

Knowing the exceptions can save people from making common mistakes, according to Ed Slott, an IRA expert and author of numerous books including “Your Complete Retirement Planning Road Map.”

For example, the laid-off often use 401(k) money to foot the bill to go back to school; they assume wrongly that the education exception that applies for IRAs carries over to 401(k)s. The 10% penalty then applies;

“That’s a mistake a lot of people make, and actually go to court to argue a case they can’t possibly win,” says Slott.

Instead, the smart thing to do would have been to roll the money into an IRA and pay for education from there, he adds.

Rande Spiegelman, vice president of financial planning at the Schwab Center for Financial Research, says making an early withdrawal should be a last resort, “somewhere right before homelessneess and/or starvation.”

Early withdrawal deletes all potential for future tax-deferred compounding, to say nothing of the taxes and penalties that can wipe out more than half of the amount withdrawn.

“Better to borrow or beg (but not steal) before raiding your retirement,” says Spiegelman.

Eisenberg advises clients who are thinking about hitting up a 401(k) to consider a loan from the 401(k) instead. A caveat here is that if the employee leaves the company with the loan outstanding, it is considered income and tax will be due on it.

By Arden Dale
A DOW JONES NEWSWIRES COLUMN

NEW YORK — It’s not just about the “nanny tax.” When using an in-home health care, it’s crucial to understand the business relationship that exists between you and the caregiver to minimize tax and legal liabilities.

With more baby boomers seeking help for aging parents, the in-home care industry is booming with a wide range of service providers, from geriatric care managers to home health-care agencies and matching services.

Contractual arrangements and employment policies vary just as widely. So it’s wise for consumers to ask questions up front about tax obligations and insurance coverage.

“Families need to be aware of all the ramifications,” says Bernard A. Krooks, a Certified Elder Law Attorney and founding partner of Littman Krooks LLP, a New York law firm.

Some families elect to privately hire a caregiver because they want to choose the person they think will be the best to provide the care. Others go to an outside party, such as home health-care agency, to find the help they need. But that doesn’t always mean they are off the legal hook.

Many nurse registries and employment agencies don’t actually employ or supervise workers — they simply find them and place them in a home setting. Under such arrangements, the family may end up being the official employer, responsible for pay, taxes and other obligations. Employing a relative or friend can put a family in the same situation.

“Household help is anyone who does help in or around your home,” says Jill Senso, education coordinator with the National Association of Tax Professionals, or NATP. “The worker becomes your employee if you control what work is done and how it is done.”

If you dictate when the caregiver is on duty and supply the equipment to provide care, you’re building an employer-employee relationship. Even a part-time caregiver can be considered an employee, especially if the caregiver doesn’t provide the same type of service to others, according to Krooks.

If you pay a household caregiver, who is your employee, more than $1,700 in 2009, the tax code requires you to withhold and pay Social Security and Medicare taxes. (The Internal Revenue Service makes some exceptions, but they typically don’t apply to situations in which adult children hire caregivers for aging parents).

If you pay the caregiver wages of more than $1,000 in any quarter, federal unemployment taxes must also be paid. State and unemployment taxes must be withheld and paid as well.

If the taxes are unpaid, the taxpayer must pay what’s owed, and will face late filing penalties of between 5% and 25% of the underpayment plus interest, according to the NATP.

Consumers can avoid tax snags if they pay an agency directly, and the agency is the caregiver’s official employer. For instance, the National Private Duty Association, NPDA, requires its members to assume all responsibility for payroll and all related taxes, according to executive director Kim Stoneking. Another option is to hire a geriatric care manager who screens, arranges, monitors and pays the caregiver on your behalf.

Employers are also responsible for verifying that workers are legally entitled to work in the U.S. An Employment Eligibility Verification form — I-9 Form — must be completed and kept on file by the employer.

Employee injuries pose one of the biggest financial risks. Federal and state laws require employers to take out workers compensation insurance; if there is none, and a caregiver is hurt on the job, the family is responsible for medical expenses and disability payments.

Consumers shouldn’t assume their homeowner’s insurance will cover this, as policies may exclude household help. They may need to buy general liability insurance.

Discrimination or harassment suits from caregivers pose another risk. An umbrella policy with a discrimination rider can provide protection, but it’s expensive, says Krooks.

Sometimes financial advisors can help families who want to hire caregivers privately. For example, Wells Fargo & Co.’s (WFC) Private Bank offers subscribers to its Elder Services program access to an outside firm, Risk Management Strategies Inc., which acts as an employer of record.

By Victoria E. Knight
A DOW JONES NEWSWIRES COLUMN

WASHINGTON — President Barack Obama is meeting strong Democratic Party resistance to his proposal to reduce tax deductions enjoyed by upper-income Americans and could be forced to drop or modify the idea.

Mr. Obama in his budget blueprint last week proposed a cap on itemized deductions for mortgage interest and charitable donations to help pay for his health-care overhaul. The plan would cost wealthier taxpayers about $318 billion in new taxes over 10 years, according to government estimates.

But after objections from Democratic lawmakers, Treasury Secretary Timothy Geithner appeared to suggest at one point Wednesday that the administration was willing to consider dropping or modifying the proposal.

The resistance from Mr. Obama’s own party — focusing on a single element of the president’s tax plans — could foreshadow broader troubles for the rest of his proposed tax increases.

Republicans have already taken aim at rate increases planned for higher-income earners, as well as the administration’s plans to raise hundreds of billions of dollars through climate-change legislation.

During two days of congressional hearings on the Obama budget blueprint this week, Democrats added their own concerns.

Sen. Max Baucus (D., Mont.), the Senate’s top tax writer as chairman of the Finance Committee, told Mr. Geithner he was especially concerned about paying for expanded health coverage with a deductions curb that “has nothing to do with health care.” He added: “I’m wondering about the viability of that provision.”

“We recognize there are other ways to do this,” Mr. Geithner responded during a hearing Wednesday. “We are willing to listen to all ideas that meet these broad principles.”

Some lawmakers questioned whether it was smart to reduce mortgage-interest deductions in the midst of a housing-market crisis.

“Isn’t there a concern that limiting the deduction would further depress home prices?” Sen. Pat Roberts (R., Kan.) asked during the hearing.

Charitable organizations are also worried. Indiana University’s Center on Philanthropy said Wednesday that Mr. Obama’s proposals to limit deductions and raise rates, if applied in 2006, would have reduced giving by nearly $4 billion, or 2.1%.

“I’d like to think that people give out of the goodness of their heart, but that tax deduction helps to loosen up the heartstrings,” Nevada Democratic Rep. Shelley Berkley said Tuesday during a House Ways and Means Committee hearing.

Mr. Baucus said the administration should look instead for ways of covering the cost of health-care reform by finding more savings within the health-care system. He suggested limiting the tax advantages of employer-provided health care.

Mr. Geithner said the proposal on limiting deductions was intended to underscore the administration’s credibility in fighting the deficit, and “to make sure the people understand that we need to do this in a way that’s broadly fiscally responsible.”

Still, Mr. Geithner repeatedly defended the proposal, saying it affects only about 1.2% of taxpayers. He added it would have only a modest negative impact on overall charitable giving. The Treasury secretary also noted that none of the administration’s tax increases would go into effect until 2011 — presumably after an economic recovery is well under way.

The Obama plan would cap the value of deductions for families making $250,000 and up. Under current law, a $1,000 deduction is worth up to $350 for such taxpayers, because they can avoid tax rates of up to 35% on that income. The Obama cap on deductions would make the $1,000 deduction worth a maximum of $280.

Mr. Geithner also faced questions from lawmakers about how Mr. Obama’s plan to let the top two tax rates increase to 39.6% and 36% in 2011 would impact small businesses. Republicans challenged Mr. Geithner’s assertion that those increases wouldn’t affect 97% of small businesses, saying the tax increases would put a new burden on businesses that create jobs.

Another Democrat, Sen. Maria Cantwell of Washington, questioned why the administration wouldn’t look for savings in the tax code through a comprehensive overhaul. “Why not look at a broader approach to tax policy, [rather] than coming in with this proposed change to marginal rates?” Ms. Cantwell said.

By John D. McKinnon andMartin Vaughan
From The Wall Street Journal

WASHINGTON — President Barack Obama on Thursday will propose $634 billion in new taxes on upper-income Americans and cuts in government spending over the next decade to pay for his promised health-care expansion.

The tax increases and spending cuts will be included Thursday in Mr. Obama’s comprehensive budget blueprint, and signal his ambition to overhaul the health-care system, one of the main planks of his presidential campaign.

The tax increases would raise an estimated $318 billion over 10 years by reducing the value of such longstanding deductions as mortgage interest and charitable contributions for people in the highest tax brackets. Households paying income taxes at the 33% and 35% rates can currently claim deductions at those rates. Under the Obama proposal, they could deduct only 28% of the value of those payments.

The changes would be phased in gradually over the next few years. For the 2009 tax year, the 33% tax bracket starts with couples with taxable earnings of $208,850, when adjusted for personal exemptions and various deductible expenses. A taxpayer in the top bracket paying $1,000 of mortgage interest, for example, would see a tax break worth $350 reduced to $280.

During his presidential campaign, Mr. Obama promised not to raise taxes on families earning under $250,000 a year, and the administration said that this plan would roughly line up with that limit.

The plan targets high-earning families in other ways. Wealthier Medicare beneficiaries would have to pay higher premiums to participate in the prescription-drug plan, much like they pay higher premiums to participate in Medicare’s doctor plan.

Aiding the other end of the income scale, the president’s budget plan would extend his tax cuts for the middle class and working poor with some of the billions of dollars raised by the sale of new carbon-emission permits for renewable energy projects. The “cap and trade” program to battle global warming would force companies to buy permits if they wish to emit heat-trapping pollutants, and they would be auctioned to businesses beginning in 2012.

The cuts in health-care spending would affect managed-care companies, prescription-drug manufacturers and hospitals, according to a senior administration official. Lobbyists representing these industries reacted mildly Wednesday, emphasizing their interest in seeing health-care reform succeed — a sign of the momentum already built behind the effort. “We will be a constructive participant in efforts to reform all parts of Medicare,” said Robert Zirkelbach, spokesman for America’s Health Insurance Plans, a lobby group.

The administration acknowledges $634 billion is not enough to pay the full cost of health-care reform that Mr. Obama and many congressional Democrats envision; the final price tag is estimated at more than $1 trillion over 10 years. The senior official who previewed the health plan Wednesday said the budget proposal is intended as a down payment and said the administration would work with Congress to find the rest.

The budget will contain few details about how Mr. Obama wants to spend the money. He campaigned on a plan to set up a government-organized marketplace where people and businesses could buy coverage from private insurers and a new government-run health plan.

The administration will release only general guidelines Thursday. Among them: Americans should have a choice of health plans and be allowed to keep their employer-sponsored plan if they wish to. It also says the plan should “put the United States on a clear path to cover all Americans.” More details are expected next week at a White House summit on health care.

The budget blueprint focuses on where the money will come from to pay for it all — half from savings to the health-care system and half from the tax increase.

One concern certain to get attention in Congress: whether a change to the deductions formula would discourage charitable giving among the wealthy, or further depress the housing market given that the interest deduction would fall for some.

The biggest chunk of savings in the budget proposal, estimated at $177 billion over 10 years, would come from changing the pay structure for private managed-care plans that participate in Medicare. Under current law, payments for Medicare Advantage plans are set by a formula, and the result is that private companies are paid, on average, 14% more to care for a Medicare patient than the government would normally spend through the traditional Medicare plan.

The Obama plan would have private plans bid to offer coverage in geographic areas; they would be paid based on an average of the bids. The administration estimates the result would be lower average costs.

Many of the initiatives are also aimed at improving quality, by linking the payments to hospitals and doctors with the quality of care they provide.

The changes being proposed for hospitals would create one bundled Medicare payment to cover both a hospital stay and care for the patient for 30 days after release, a change estimated to save $17 billion over 10 years. The administration is also proposing to cut payments for hospitals that routinely readmit patients after they have been discharged, a sign that the original care was substandard. That change would save $8.4 billion over 10 years.

Mr. Obama’s budget proposal signals he is serious about fulfilling his pledge to enact comprehensive health-care legislation this year, a promise he repeated Tuesday during his address to Congress.

It is also a sign he plans to turn aggressively to the ambitious domestic policy agenda he laid out during the presidential campaign — an agenda curtailed during his first weeks in office by the financial crisis.

Mr. Obama and his aides spent Wednesday putting the finishing touches on the budget blueprint, kicking off the process of rewriting the rules for financial regulation and initiating so-called stress tests to gauge the viability of the country’s tottering banks.

The budget plan will go through a rigorous congressional review before it becomes law. But, particularly in the first year of a presidency, the budge document is significant as a broad statement about the new administration’s agenda. The budget document will also include an energy plan aimed at controlling carbon emissions, new funding for preschool and higher education, as well as an outline for narrowing a federal deficit that now tops $1 trillion.

Mr. Obama’s 10-year blueprint is also expected to contain a large number of tax increases, in addition to the one proposed to cover health care. It will mark a sharp shift from the budgets proposed by President George W. Bush, with sharply reduced tax rates across the board. Mr. Obama will propose letting Mr. Bush’s tax cuts on upper-income families expire in 2011, and will propose blocking the estate tax from disappearing as scheduled under current law. He’ll also propose a number of taxes on companies, one aimed at blocking companies from moving jobs overseas and others that the administration will portray as “closing loopholes.”

 By Laura Meckler
Of THE WALL STREET JOURNAL 
 

NEW YORK — That nice nephew you’re leaving something to when you die? He may actually wind up empty-handed.

And it won’t be because you changed your will, but because you didn’t.

Two events — important changes in the tax laws and a brutal decline in the markets — are combining to raise the chances of accidentally disinheriting someone. At the least, you could lose control over how much your beneficiaries wind up with.

This year, the estate tax exemption jumped to $3.5 million from $2 million. So, estates aren’t taxed federally until they reach $3.5 million.

Changes in the law may lead to “unintended consequences in your will,” says Steven Lavner, senior vice president in the national wealth planning strategies group in the New York office of U.S. Trust, Bank of America Private Wealth Management.

Here’s one problem: Many wills bequeath the estate exemption amount — whatever it is under the law rather than a specific dollar figure — to a family trust (sometimes called a bypass trust, and often destined for children). The rest generally goes to a spousewho can inherit from his or her mate without being taxed.

Last year such a will, for a $5 million estate, would have left $2 million to the family trust and the other $3 million to the spouse. But this year, it would leave $3.5 million to the trust and $1.5 million, perhaps much less than intended, to the spouse.

The markets slump may complicate matters further: Say if that $5 million estate had shrunk to $3 million, so that the terms of the will put it all in the trust. The spouse would get nothing.

It’s smart to “step back and ask yourself how the money is really flowing and whether you need to update the plan,” said M. Holly Isdale, managing director and deputy head of family wealth advisory services at Bessemer Trust.

A key to the review is making sure you can still fund the will. The new, higher exemption means each spouse may need more assets in his or her name. Jointly owned assets go automatically to the surviving spouse when the first dies. So, if the husband passes away first in a couple with everything titled in joint names, the assets won’t be available to fund his will, according to Lavner.

State estate taxes also need a careful look. Many states have a death tax, and most of them set the exemption lower than the current federal estate tax.

Planning can get “enormously complicated” because of the difference between state and federal estate taxes, according to Jere Doyle, senior vice president at BNY Mellon Wealth Management.

The different state estate tax levels can also confuse things.

One estate planner tells of a client in New York whose mother was in a coma. The client had to weigh whether to move the mother to his state — even though estate taxes were higher.

As states become more pressed for money, there are a lot of “issues about whether you’re really a resident of a certain states,” says Isdale. Two or more states may even try to claim someone as a resident, she added.

A way to deal with this is to make sure trust documents are flexible to allow for several outcomes, as advisers rarely know in which state a client will die, according to Doyle.

The exemption hike this year is the latest in a series of estate tax changes that have severely complicated estate planning for the past several years. A 2001 law phased them in after a political battle over repeal. In 2007 and 2008, estates over $2 million could be taxed as much as 45%. In 2009, the threshold rose to $3.5 million.

In 2010, the estate tax is set to be fully repealed for a year, then reinstated in 2011 on estates over $1 million. But many tax advisers expect Congress to change the law this year to levy an estate tax for 2010.

By Arden Dale
Of DOW JONES NEWSWIRES

Expect An Audit: The Estate Tax Audit Rate Is Skyrocketing

There’s an important-yet unspoken-phenomenon in the world of estate tax: As the number of estate tax filings has been decreasing nationwide since 2001, there’s been a corresponding increase in the Internal Revenue Service’s audit coverage rate of estate tax returns-from 20 percent to nearly 100 percent. Indeed, at least for the next few years, practitioners should change their assumption from “Federal estate tax returns may be audited,” to “These returns will be audited.” And of course that means all estate-planning attorneys and accountants should be more careful than ever before, when planning a client’s estate.

What makes the IRS’ ever-increasing vigilance possible? Well, one implication of the 2008 election results is that we can safely rule out any near-term possibility of an outright repeal of the federal estate
tax. If President Barack Obama holds true to his pre-election tax proposals, the 2009 federal estate tax law will be extended into 2010 and beyond, maintaining the $3.5 million estate tax exemption (possibly indexed for inflation) with a 45 percent estate tax rate for the foreseeable future.

The leap this year to a $3.5 million estate tax exemption from the previous $2 million exemption will be the sharpest single-year increase in the estate tax exemption, both in terms of a dollar amount increase and on a percentage basis, since the modern estate tax was first enacted in 1916. It’s been estimated that the $3.5 million exemption will shelter roughly 99.5 percent of all estates from the federal estate tax.

Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the number of estates required to file a federal estate tax return (Form 706) has been steadily declining nationwide. It
went from an annual total of 108,071 returns filed as recently as in 2001, to a mere 38,031 returns filed in all of 2007.

The Facts, and Just the Facts

If the established pattern continues, under which about 45 percent of the total number of federal estate tax returns filed nationwide are taxable, less than 8,000 taxable estate tax returns will be filed in 2010-a drop of approximately 85 percent over a nine-year period.

Yet there’s an inverse relationship between the number of estate tax filings and the audit coverage rate. That is to say, as the number of estate tax filings decreases nationwide, there is a corresponding
increase in the audit coverage rate of estate tax returns by the IRS.

In 2001, when 108,071 federal estate tax returns were filed nationwide, there were about 350 attorneys in the IRS Estate and Gift Tax Program auditing federal estate tax returns nationwide.

With a staff of about 350 auditors, there were slightly more than 300 federal estate tax returns filed for every auditor in 2001. IRS estate tax attorneys are informally expected to close about 30 examined
estate tax cases annually with some degree of substantive adjustment. Consequently, about 10 percent of all federal estate tax returns (those that are taxable and those that are not) were being thoroughly audited by the IRS in 2001. By 2005, when the total number of federal estate tax returns had dropped to 45,070, there were only about 129 returns being filed for every auditor. The estate tax audit rate had jumped to 24 percent. These audit rates are dramatically higher than the 1 percent to 2 percent audit rate for individual income tax returns.

Of course, the audit coverage rate for taxable estate tax returns has risen even more dramatically. In 2001, it was 20 percent, because there were about 150 taxable estate tax returns filed for every auditor. By 2005, the audit rate for taxable estate tax returns was over 50 percent. In 2010, the year after the federal estate tax exemption will have risen to $3.5 million, the IRS has projected that 17,500 federal estate tax returns will be filed nationwide. If there are still 270 auditors, the audit rate for taxable returns will be virtually 100 percent.

You’ve Been Warned

What should tax practitioners take away from these projected trends in the audit coverage rate of federal estate tax returns?

Estate planners will do well by their clients to ask themselves at the earliest planning stage how a proposed transaction is likely to withstand IRS scrutiny. Particular attention should be paid to how hard-to-value assets are reported on an estate tax return. Transactions involving family limited partnerships and other techniques that the IRS considers potentially abusive will continue to trigger closer scrutiny.

In general, tax professionals serve their client’s best interests by preparing all tax returns with the assumption that the IRS may audit their work product.

By Richard A. Behrendt

President-elect Barack Obama and congressional leaders plan to move soon to block the estate tax from disappearing in 2010, suggesting the levy might outlive the “Death Tax Repeal” movement that has tried mightily to kill it.

The Democratic stance on the estate tax contrasts with Mr. Obama’s reluctance to press forward with his campaign pledge to raise income-tax rates on top earners, which he worries could have an adverse economic impact during a recession.

But Democrats are determined to act quickly to prevent the estate tax’s scheduled repeal. Elimination of the levy on big inheritances was approved by Congress under President George W. Bush in 2001, with rollbacks phased in slowly and its full elimination slated to take effect next year.

The Senate Finance Committee will move within weeks on legislation to reverse that law, and Mr. Obama is expected to detail his estate-tax preservation proposal in his budget next month, congressional tax writers said.

Under the Obama plan detailed during the campaign, the estate tax would be locked in permanently at the rate and exemption levels that took effect this year. That would exempt estates of $3.5 million — $7 million for couples — from any taxation. The value of estates above that would be taxed at 45%. If the tax were returned to Clinton-era levels, it would exclude $1 million from taxation with the rest taxed at 55%.

In making their case for the restoration, Democrats contend that such a large additional tax break for the rich shouldn’t go into force halfway through Mr. Obama’s proposed economic-recovery package. They argue that the deficit is already in record territory, while their plan wouldn’t have any impact on the economy since it would merely keep the estate-tax rate at its current level. Mr. Obama and his party also say that the affluent already have benefited handsomely from the Bush tax cuts.

They also reason that if they don’t act now, it will be politically harder to go ahead with their plan to resurrect the estate tax once it has disappeared.

For small-business groups, farmers” associations and the affluent families that created and bankrolled the “Death Tax” repeal effort, the emerging Democratic plan marks a stark defeat.

Advocates of killing off the tax say the emerging Obama policy is the wrong medicine for the recession, arguing the levy is economically burdensome like the income tax. Bill Rys, tax counsel for the National Federation of Independent Business, said small businesses struggling with falling sales and layoffs shouldn’t have to devote resources to estate planning.

“With auto sales at a 16-year low, dealerships are already struggling. Freezing the 2009 levels would put an even greater burden on the future,” said Bailey Wood, chief lobbyist for the National Automobile Dealers Association.

At the level proposed in the Obama policy, all but the largest estates — fewer than 2% of annual deaths — would escape taxation. Over 10 years, the Obama plan would cost the Treasury around $324 billion more than if the Clinton estate-tax levels were maintained, according to the Joint Committee on Taxation. Full repeal would cost more than $500 billion over a decade.

The estate tax was enacted in the early 20th century as a levy on wealth and inherited assets. It was later amended to allow a spouse to avoid the tax.

Most such taxes are still collected from estates of the ultra-rich. But business and farm groups say small businesses and family farms struggle with it as well, at the very least devoting time and energy to planning ways to escape or minimize taxation as enterprises pass from generation to generation.

Patricia Soldano, an estate-tax planner in Southern California, was a pioneer of the movement launched in the mid-1980s. Backed by affluent families such as the Mars candy family, the Gallo wine family and the heirs of the Campbell’s soup fortune, Ms. Soldano enlisted Republican pollster Frank Luntz to poll-test the “Death Tax” term, forged alliances with the young Republicans who would sweep to power in 1994 and teamed up with small-business and farm groups.

By framing it as a tax on dying rather than wealth and thrusting family farms and small businesses front and center, the movement was able to divorce the cause from the issue of dynastic wealth and broaden its appeal to Main Street advocates.

The campaign seemed to have succeeded in 2001 when, with huge projected budget surpluses, Mr. Bush pushed and Congress approved an estate-tax repeal.

But to win the necessary votes for the larger, $1.35 trillion tax cut of which it was part, Republican leaders used legislative tactics that mandated the entire tax package expire in a decade. To lower the 10-year cost, the estate tax didn’t begin dropping significantly until the end of the window and wouldn’t disappear until 2010.

During the long phase-in, the politics have begun to shift again. Almost since the change was put in place, repeal advocates have pushed for an earlier permanent elimination in the face of huge budget deficits, with no luck. They always sensed an estate-tax elimination set far in the future was tenuous at best, especially since the law as written has the repeal last only one year.

Then, anticipating Democratic majorities in Congress that would ultimately seek to block full repeal, the coalition began seeking compromises that would leave a minimal tax in place for a tiny fraction of estates. Estate-tax opponents agreed they would get the best possible deal with Mr. Bush still in office.

But sharp divisions in the coalition emerged between the super rich and the merely rich. Business groups have sought a measure of certainty with an estate tax that is free of graduated timelines or sunset provisions, with the largest possible tax exemption — $10 million, or $20 million per couple. The rate of taxation above that level was of little concern, since virtually every small business would be exempt from taxation.

Yet the super affluent who began the movement wanted the lowest possible rate, since even a $10 million exemption would leave the bulk of their estates subject to tax. They backed a call by Mark Bloomfield of the American Council for Capital Formation to tax all estate transfers as capital gains, at 15%, with little or no exemption.

“The very wealthy, in their quest to reduce their exposure, made proposals that threw the small-business community overboard,” said one prominent small-business lobbyist, referring to a move to have estates taxed as capital gains upon their disposition, without regard to the amount shielded from taxation.

Ms. Soldano said “the small-business people were being shortsighted in thinking, ‘Let’s just fix it now for me.’”

Former Sen. Don Nickles, an Oklahoma Republican who fought the tax his entire political career, said he and Arizona Republican Sen. Jon Kyl must have given 10 speeches to the movement, exhorting them to come together and accept the best that could pass Congress while the GOP had control.

Now, the movement is likely to confront an estate tax that is far bigger than what it may have gotten with more compromise.

“People mistook political reality,” Mr. Bloomfield said. “The end result is we’ll have a worse tax policy than if Sen. Kyl had succeeded.”

Senate Finance Committee Chairman Max Baucus said in a recent interview that he will move “in the next few weeks” on legislation to deal with urgent tax matters not related to any economic stimulus. Estate-tax preservation will be front and center, an aide to the Montana Democrat said.

But movement veterans are already conceding defeat is likely. “I am disappointed,” Ms. Soldano said, “because I really thought we could achieve so much more.”

By Jonathan Weisman
THE WALL STREET JOURNAL

NEW YORK — The affluent and those of modest income alike stand to gain from an Internal Revenue Service pledge to go easier on taxpayers who can’t pay what they owe during the current tough economy.

Details of an IRS plan to soften its approach remain sketchy, however. Tax advisers who work on collections issues say they have doubts about if and how it will really work.

IRS Commissioner Doug Shulman said this week the agency is taking five steps to help financially distressed taxpayers. They include letting some who face difficulties defer taxes.

“Each one of these sounds great, but I’m just asking for the details,” said Robert E. McKenzie, a partner in the Chicago law firm Arnstein & Lehr LLP and the author of several books on the IRS and U.S. Tax Court. The IRS recently named him to its Advisory Council.

Low- and moderate-income taxpayers have long faced draconian IRS collection policies that needed reforming, according to McKenzie. Wealthy clients who have lost a fortune in the stock market will need new flexibility the IRS plans to offer, according to tax advisers.

Nonetheless, no taxpayer should take anything for granted as the agency attempts to take a softer line on collecting from those facing a job loss or other difficulties such as steep, unexpected medical costs. The IRS has historically taken a hard line in collecting, according to accountants and tax attorneys.

“I’d say it’s a dramatic departure from the current policies of the IRS, and one would hope they succeed in moving in a more reasonable direction,” said William E. Halmkin, a tax and litigation partner in the Boston office of law firm Sullivan & Worcester and formerly the deputy commissioner of the Massachusetts Department of Revenue.

Halmkin said he is hopeful the IRS will be able to enforce the new approach.

IRS Plan Has Several Parts

Shulman said he has given tax assisters greater authority to suspend collection actions for taxpayers facing a job loss, unexpected medical bills or other difficulties.

Tax debt won’t be forgiven in these cases, but the IRS will defer collection activity, including notices and phone calls, levies, seizures and penalties, IRS officials said.

Secondly, taxpayers who miss a payment under an installment agreement with the IRS won’t automatically have their agreement suspended.

The IRS will also broaden eligibility for its “offer in compromise” program by considering some taxpayers who appear to have enough equity in their home to cover their tax debt. Under an offer in compromise, a taxpayer can settle with the IRS for less than the full amount of taxes owed.

In the past, offers in compromise have not been considered from such taxpayers.

Robert Willens, a tax analyst at Robert Willens LLC, said he thinks the IRS initiative may embolden advisers to seek more offers in compromise.

Shulman said he has established a special unit to review specific cases where taxpayers with equity in real property may be eligible for an offer in compromise.

Also, taxpayers who miss a payment under an existing offer-in-compromise agreement can work with IRS officials to avoid defaulting on that agreement.

Finally, Shulman said the IRS will speed levy releases for taxpayers in financial hardship. This should make it easier for those behind on their taxes to stop the IRS from garnishing their wages, a practice that can be devastating for struggling families, according to McKenzie.

Taxpayers who are having difficulty meeting their obligations should contact the IRS to take advantage of the new flexibility, Shulman said.

Tax advisers say it’s crucial to reach a real person rather than relying on automated systems that are used to handle some collections.

The key is to stay in contact with the IRS, not “put your head in the sand,” said Claudia Hill, who owns the tax services company Tax Mam, Inc. in Cupertino, Calif.

Upscale taxpayers who have lost their jobs or seen businesses go under are still going to have a hard time convincing the IRS to be flexible in collecting taxes, according to Hill.

The IRS “can tell you that if they owe more $25,000, they are still going to have to jump through hoops and will still be working with people who don’t understand,” said Hill.

By Arden Dale
A DOW JONES NEWSWIRES COLUMN