Investment Strategies

Congress provides certainty on taxes — at least for now

House approval of compromise locks in rates on income and estates through 2012

Dec 19, 2010 @ 12:01 am

By Mark Schoeff Jr.

Investment advisers now can confidently tell their clients they don't need to rush stock or real estate sales, or scramble to gift chunks of their estate to heirs before the end of the year.

With the House vote late last Thursday to extend Bush-era tax cuts, Congress has provided advisers with some much-needed certainty — at least for the moment. The bill, which President Barack Obama signed on Friday, locks in the current marginal tax rates for all income levels. The measure also sets new parameters for the estate tax, creates a raft of other individual and business tax breaks, and extends unemployment benefits.

While the $858 billion bill offers a measure of relief for planners and advisers, it may be only temporary. Most of the measure's provisions will expire in 2012 unless they are renewed again.


“The good news is that you have certainty for now,” said David Tittsworth, executive director of the Investment Adviser Association in Washington. “The bad news is that they just kicked the can down the road.”

The House approved the bill 277-148. Earlier in the week, the Senate had passed the measure 81-19, giving it strong momentum to overcome resistance by most House Democrats to the estate tax portion.

Liberals railed against the bill's estate tax rate of 35% and exemption of $5 million ($10 million for couples), thresholds that would require only about 3,600 estates to pay the tax, according to the Tax Policy Center.

Indeed, most Democrats were incensed by what they called a giveaway to the rich, piled on top of maintaining tax cuts for the highest earners. Nevertheless, an amendment to set the estate tax rate at 45% with a $3.5 million exemption — reflecting a bill the House passed in 2009 — failed 233-194.

The bill was based on a compromise between Mr. Obama, who wanted to limit the Bush-era tax break extensions to individuals making less than $200,000 and couples earning less than $250,000, and congressional Republicans, who wanted to make the reductions permanent for every income level. The GOP argued that raising taxes on anyone would undermine a sluggish economic recovery.

If Congress had not acted before Dec. 31, all the Bush tax cuts would have expired. The estate tax, which was not in effect this year, would have shot up to 55% with a $1 million exemption.

The bill also eliminates the so-called “carry-over” basis in place in 2010, which requires valuing inherited assets based on their original purchase price, and reinstates the step-up in basis that allows them to be priced at fair market value. Executors for anyone who died in 2010 can choose either system.

The bill maintains a 15% rate for capital gains and dividends. If the Bush cuts had lapsed, the capital gains rate would have risen to 20% while dividends would have been taxed as ordinary income.

In addition, the measure will raise the amount of income exempt from the alternative minimum tax. For tax year 2010, the AMT threshold will be bumped up to $47,450 for individuals and $72,450 for couples filing jointly. The year after, the bar will rise to $48,450 for individuals and $74,450 for couples. Moreover, taxpayers will be permitted to apply non-refundable credits — credits that reduce a filer's tax bill — to their tax liability under either the AMT or the regular tax code.


Though the tax levels set in the bill are temporary, advisers and estate lawyers are relieved that they finally have a backboard to play off of when providing guidance to clients.

“At least we are doing a two-year extension with some of the fundamentals in place — a tax and an exemption,” said Jean Gordon Carter, a partner at Hunton & Williams LLP. “It's still a mess, but not quite as big a mess.”

The bill doesn't facilitate the formulation of broad strategies for clients, but it does illuminate short-term decisions, according to Rial Moulton, co-founder of Retirement and Tax Planning Specialists.

For instance, clients don't need to unload stock or real estate in the next two weeks to avoid a rise in the capital gains tax. And they don't need to parcel out their estates to take advantage of the current 35% gift tax rate.

“As far as short-term planning, it helps,” Mr. Moulton said. “Now, there's no pressure to sell by the end of the year.”

Businesses that operate on a longer time frame — say, for investing in a five-year project — will not benefit as much from the implementation of two years of favorable tax treatment.

“That will probably have a disproportionate effect on anything that requires a large capital expenditure,” said Patrick Cox, chief executive of Taxmasters. “You have three years where you don't know what the rate is, and how that's going to affect the return on the project you're considering?”

If business leaders hesitate to make investments in their operations, it could undermine one of the primary goals of the bill — creating jobs. The fact that the $858 billion in spending was not paid for with corresponding cutbacks will exacerbate the flow of federal red ink.

“This was a missed opportunity in terms of beginning the very difficult process of deficit reduction,” Mr. Tittsworth said. The Obama-GOP agreement “could have been so much better.”

Although Republicans and Democrats came together to extend the Bush tax cuts, it's unlikely a harbinger of the bipartisanship required to do the much more politically difficult task of reforming the tax system.

The next Congress will tackle the budget deficit by zeroing in on spending, entitlements and taxes, according to Andrew Friedman, principal at The Washington Update.

“I think they come up in that order,” Mr. Friedman added. “It's tough to do [tax reform] in one year, and it's tough to do it in an election year. That throws it three to four years down the road.”

In the meantime, advisers can exhale. They now know that the Bush tax rates — along with a lower estate tax rate and a generous exemption — will be in place for at least two of those years.

E-mail Mark Schoeff Jr. at


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