2010 Tax Relief Act
Last week was a monumental week for US tax practitioners. On Friday, December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (affectionately known as the “2010 Tax Relief Act” or “TRUIRJCA”). While it does not provide long-term certainty, Americans (and Canadians with permanent establishments in the US) can at least be assured that for the next two years, individual and corporate tax rates will remain at 2001 levels. Additionally, dividend rates (which were scheduled to increase to ordinary income rates) and capital gains rates (scheduled to increase to 20 percent) will likewise remain at the 15 percent 2001 rate. Other notable changes to the income tax include an increase in the exemption amount for the alternative minimum tax and a decrease to the employee-share of a portion of Social Security taxes from 6.2 percent to 4.2 percent. Finally, businesses are allowed a 100 percent deduction for qualified property purchased between September 9, 2010, and December 31, 2011, that they were previously required to amortize and depreciate.
As we discussed in our previous blog on December 7, 2010, the 2010 Tax Relief Act makes major changes to the estate tax. In addition to raising the exemption amount from its 2009 level of $3.5 million to $5 million and lowering the 2009 level of tax from 45 percent to 35 percent, the new Act makes several other changes to the estate, gift and generation skipping transfer (“GST”) taxes. First, the 2011 Tax Relief Act allows estates of decedents dying in 2010 to elect out of the estate tax (with the higher exemption amounts and lower rates). Modest estates (i.e. those with net assets of less than $5 to 6 million) might benefit from paying the tax because assets in the estate would receive a step-up in basis that could be more valuable than any estate tax savings. Suppose the estate of a single decedent is worth $5.5 million, but has $5 million in unrealized capital appreciation. The estate would either owe $175,000 in estate taxes (35 percent of $500,000 net estate) and receive a $5.5 million basis or it could elect to file under the 2010 rules, in which case it would owe nothing in estate taxes. However, when the beneficiaries sell the inherited property, they may owe a combined total of $750,000 in income taxes ($5 million at 15 percent).
Second, the 2010 Tax Relief Act provides for portability of exemptions between spouses. That is, if a surviving spouse’s husband or wife dies in 2011 or 2012 and does not use his or her entire exemption amount, the unused amount will be added to the surviving spouse’s exemption amount. For example, suppose that Husband and Wife have a combined estate of $10 million. Suppose further that Husband makes a $1 million taxable gift then dies in 2011, leaving his entire estate to his Wife. Had Wife died in 2009, she would have a $9 million estate, all but $3.5 million (the 2009 exemption amount) of which would be taxable. Now, provided that Wife did not remarry, she may add her husband’s unused $4 million exemption to her $5 million exemption, making the entire estate free of taxes.
Note there is a different result where one of the two spouses is not a citizen of the US. Husband’s estate would not receive a deduction for the $4 million bequest to non-citizen Wife unless the property is transferred to a qualified domestic trust or Wife becomes a citizen shortly after Husband’s death. As written, it would appear that the surviving spouse of a non-resident, non-citizen 2011 decedent in a treaty country (like Canada) will have some ability to use the unused portion of his or her spouse’s exemption so long as an estate tax return is timely filed for the non-citizen decedent spouse.
Finally, the 2010 Tax Relief Act unifies the gift, estate, and GST tax exemptions. Thus, a US citizen making a taxable gift of $1 million uses $1 million of his unified exemption amount, leaving a $4 million exemption for his estate. The exemption for the gift tax is not available for non-resident, non-citizens.
IRS Commissioner Doug Shulman comments on international tax issues
Just in case you thought the IRS has forgotten about Americans living abroad and Americans with interests in foreign entities, this should open your eyes. In a speech given last week at the 23rd Annual Institute on Current Issues in International Taxation in Washington DC, IRS Commissioner Shulman used strong rhetoric to admonish Americans who have not been reporting income in foreign accounts and deceptively soft words to describe the IRS’s new “cooperative” approach to multinational audits.
In discussing individual offshore compliance, the Commissioner pointed to two issues: the UBS affair and FATCA, as discussed in our February 10, 2010 blog. Shulman stated that the IRS had “made cracking down on offshore tax abuse a major priority,” and flatly stated that UBS was just the beginning. From his comment that “this was never about one country or one bank,” I think it’s safe to expect investigations like the ones in Switzerland to proliferate throughout the globe.
Shulman named FATCA as “one of the most important projects we are working on in the international area right now.” He stated that “FATCA provides IRS with better transparency and additional tools that [it] needs to crack down on Americans hiding assets overseas.” The Commissioner also mentioned the “stiff penalties” that would be imposed for failure to comply and voiced his hope that all countries would develop a “unified system for information reporting”.
In discussing corporate taxpayers, Shulman discussed the new cooperative approach, transfer pricing and joint audits. The Commissioner wants to “redefine the relationship between the IRS and large corporate taxpayers.” This seems to be a reference to the new IRS practice of requesting documents that prior to last year’s Textron decision many practitioners would have thought were not discoverable under the US work-product privilege. He also identified transfer pricing as an area on which the IRS has been focusing.
Finally, the IRS commissioner stated that the IRS has been pushing joint audits through the OECD’s Forum on Tax Administration. Noting that it can cost companies a considerable amount of time and money to defend its positions to multiple international jurisdictions, Shulman heralded joint audits as a method by which the IRS could “identify the issue and understand the facts quickly on a bi- or multi-lateral basis [and] adjudicate these disagreements right away and be much more efficient in reaching a resolution.”
A full copy of the IRS Commissioner’s comments can be found here.