SUMMARY OF THE JOBS AND GROWTH RELIEF

RECONCILIATION ACT OF 2003

AND

OTHER RECENT DEVELOPMENTS

 

I.      SUMMARY OF NEW LONG TERM CAPITAL GAINS RATES

 

Date of Sale	Capital Gains Rate for 10% or 15% Tax Bracket	Capital Gains Rate For All Other Brackets
2002 to May 5, 2003	10%	20%
After May 5, 2003	5%	15%
2004-2007	5%	15%
2008	0%	15%
2009	10%	20%

 

 

A.     For taxpayers in the 25%-35% tax brackets, the tax rate on gain from the sale of a capital asset is fifteen percent (15%).

 

B.     The fifteen percent (15%) tax rate applies for sales occurring after May 5, 2003 and on or before December 31, 2008.

 

C.     Historically low capital gains tax rates for next four plus years (or less!!) creates a window of planning opportunities:

 

1.     Sale of Highly Appreciated Assets.  With low capital gains tax rates in effect and limitations on the step-up in basis of assets at death on the horizon, NOW IS AN EXCELLENT TIME TO SELL HIGHLY APPRECIATED ASSETS!!!

 

                        a.     Concentrated stock positions.

 

                        b.     Employer stock in 401(k) plans.

 

                2.     Electing Out of Installment Sale Reporting.

 

a.     Installment Sales.  When at least one payment is received by the seller of an asset in a tax year after the year of sale, a cash basis seller must report the gain using the installment sales method.  By using the installment sale method, gain is prorated and recognized over the years in which payments are received.  See Code Section 453.

 

i.      Taxpayer calculates installment sale income each year on Form 6252.

 

ii.     The amount of installment sale income is then transferred to Schedule D as long-term capital gain or short-term capital gain, as the case may be (if the installment sale income is from the sale of a business asset, Form 4797 is used instead of Schedule D).

 

iii.     The amount of installment sale income is included with other capital gains on Schedule D and taxed at that year’s capital gains rate.

 

b.     Electing Out.  Code Section 453(d) allows a taxpayer to make an election to report the entire gain from an installment sale on the taxpayer’s return for the year of sale.

 

i.      Treasury Regulations require the election to be made on or before the due date for filing the taxpayer’s return for the taxable year in which the installment sale occurs. 

 

ii.     A taxpayer who wants to elect out of installment sale reporting does not report the sale on Form 6252, but rather reports the full amount of the gain from the installment sale on Schedule D (or Form 4797 if a business asset is sold). 

 

3.     The Kibosh on Charitable Remainder Trusts. Often the most significant reason for doing a charitable remainder trust (CRT) is that upon a sale of appreciated assets by the CRT, the resulting capital     gain is not immediately recognized.  Therefore, taxpayers desirous of maximizing current income can invest 100% of the pre-tax net sales proceeds to earn income over time. With the reduction in  capital gains rates to 15% for most taxpayers, the difference between the income which can be earned from the CRT and the income earned by the taxpayer by selling the assets outside a CRT and investing the after tax proceeds is less significant.

 

4.     Reduction in the Tax Costs of Gifting.  Often the most significant income tax cost to gifting during life is the loss of the ability to obtain a step-up in the basis of the asset at death.  Obtaining a carry over basis in a gifted asset is less troublesome with lower capital gains rates.

 

II.    REDUCTION IN FEDERAL ORDINARY INCOME TAX RATES

 

 

Married Individuals Filing Jointly And Surviving Spouses

Prior Law

 

If Taxable Income Is:	The Tax Is:
Not Over $12,000	10% of taxable income
Over $12,000 but not over $47,450	$1,200.00 plus 15.0% of the excess over $12,000
Over $47,450 but not over $114,650	$6,517.00 plus 27.0% of the excess over $47,450
Over $114,650 but not over $174,700	$24,661.50 plus 30.0% of the excess over $114,650
Over $174,700 but not over $311,950	$42,676.50 plus 35.0% of the excess over $174,700
Over $311,950	$90,714.00 plus 38.6% of the excess over $311,950

 

 

 

 

Effective January 1, 2003

(changes in bold)

 

If Taxable Income Is:	The Tax Is:
Not Over $14,000	10% of taxable income
Over $14,000 but not over $56,800	$1,400.00 plus 15.0% of the excess over $14,000
Over $56,800 but not over $114,650	$7,820.00 plus 25.0% of the excess over $56,800
Over $114,650 but not over $174,700	$22,282.50 plus 28.0% of the excess over $114,650
Over $174,700 but not over $311,950	$39,096.50 plus 33.0% of the excess over $174,700
Over $311,950	$84,389.00 plus 35.0% of the excess over $311,950

 

 

Unmarried Individuals

Prior Law

 

If Taxable Income Is:	The Tax Is:
Not Over $6,000	10% of taxable income
Over $6,000 but not over $28,400	$600.00 plus 15.0% of the excess over $6,000
Over $28,400 but not over $68,800	$3,960.00 plus 27.0% of the excess over $28,400
Over $68,800 but not over $143,500	$14,868 plus 30.0% of the excess over $68,800
Over $143,500 but not over $311,950	$37,278 plus 35.0% of the excess over $143,500
Over $311,950	$96,235.50 plus 38.6% of the excess over $311,950

 

 

 

Effective January 1, 2003

(changes in bold)

 

If Taxable Income Is:	The Tax Is:
Not Over $7,000	10% of taxable income
Over $7,000 but not over $28,400	$700.00 plus 15.0% of the excess over $7,000
Over $28,400 but not over $68,800	$3,910.00 plus 25.0% of the excess over $28,400
Over $68,800 but not over $143,500	$14,010.00 plus 28.0% of the excess over $68,800
Over $143,500 but not over $311,950	$34,926.00 plus 33.0% of the excess over $143,500
Over $311,950	$90,514.50 plus 35.0% of the excess over $311,950

       

 

 

A.     Back to the Future.  Income tax rates are the lowest since the passage of the Tax Reform Act of 1986.  With rising Federal budget deficits, low income tax rates on ordinary income may not be around forever.       

 

B.     Planning Opportunities.  Look for the planning opportunities that were in vogue in the late 1980s to return to prominence.  They involve accelerating the recognition of ordinary income:

 

1.     The Secular Trust (the antithesis of the “rabbi trust”) and other Forms of Nonqualified Deferred Compensation.

 

a.     The secular trust is an irrevocable trust established to fund and secure the payment of non-qualified deferred compensation benefits.

 

b.     Funds placed in the secular trust are not subject to the claims of creditors of the employer.

                 

c.      Employer contributions to a secular trust are immediately taxed to the employee to the extent the employee’s interest is substantially vested; that is, it is not subject to a substantial risk of forfeiture.

 

2.     Exercising Nonqualified Stock Options.  Generally, the exercise of nonqualified stock options results in ordinary wage income in an amount equal to the difference between the fair market value of the stock upon exercise and the exercise or strike price.

 

3.     Section 83(b) Elections.  The grant of a nonqualified stock option that does not have a readily ascertainable value is not a taxable event.  Rather ordinary income is recognized upon exercise unless the stock transferred is nontransferable and subject to a substantial right of forfeiture in which case the income is recognized when the restrictions lapse.

 

a.     Pursuant to Code Section 83(b) a taxpayer can elect to close the compensation element on a restricted property transaction at the time the property is transferred (upon exercise of the option).  Any post-exercise appreciation in the stock is converted into capital gains, and no taxable event occurs when the restrictions subsequently lapse.

                       

b.     The holding period in the stock begins on the date the restrictions lapse.      

 

c.      The Code Section 83(b) election must be made within 30 days of the exercise of the option, and the election is irrevocable.

 

d.     If the restricted stock is untimely forfeited as a result of the restrictions, the taxpayer does not get a tax deduction equal    to the amount of income previously recognized.  Instead, the taxpayer is allowed a capital loss deduction.

 

4.     Roth Conversions.  Low ordinary income tax rates reduces the pain of converting a traditional IRA to a Roth IRA.  This strategy is particularly attractive in depressed equity markets.

                         

 

 

III.    SUMMARY OF NEW RATES FOR DIVIDENDS TAXED AS CAPITAL GAINS

 

Date	Rate for 10% or 15% Tax Bracket	Rate For All Other Brackets
2002	N/A	N/A
2003	5%	15%
2004-2007	5%	15%
2008	0%	15%
2009	N/A	N/A

 

 

A.     Embracing Family Attribution.

 

1.     In the arena of family business succession planning, the family attribution rules often prevented a senior family member from receiving capital gain treatment on a redemption of stock from a family owned C corporation, and family attribution could not be waived in cases where prior gifting was involved.

 

2.     Dividend treatment to a senior family member can now be preferential where the corporation’s taxable income is taxed at the lower 15% and 25% tax rates, and the dividends are taxed to the senior family member at a 15% tax rate.

 

B.     Query for Trust Officers.  To what extent do the lower income tax rates applicable to dividends (versus interest income) create an incentive to invest a greater percentage of a portfolio in dividend paying stocks which carry more risk?

 

 

IV.    FEDERAL ESTATE TAX LAW CHANGES INCLUDED IN THE ECONOMIC GROWTH AND TAX RELIEF RECONCILIATION ACT OF 2001

 

Calendar Year	Estate Tax Exemption	Gift Tax Exemption	GST Tax Exemption	Highest Estate and Gift Tax Rate (and GST Tax Rate)
1997	$600,000	$600,000	$1,000,000	55%*
1998	$625,000	$625,000	$1,000,000	55%*
1999	$650,000	$650,000	$1,010,000	55%*
2000	$675,000	$675,000	$1,030,000	55%*
2001	$675,000	$675,000	$1,060,000	55%*
2002	$1 million	$1 million	Indexed for inflation	50%
2003	$1 million	$1 million	Indexed for inflation	49%
2004	$1.5 million	$1 million	$1.5 million	48%
2005	$1.5 million	$1 million	$1.5 million	47%
2006	$2 million	$1 million	$2 million	46%
2007	$2 million	$1 million	$2 million	45%
2008	$2 million	$1 million	$2 million	45%
2009	$3.5 million	$1 million	$3.5 million	45%
2010	Tax repealed	$1 million	Tax Repealed	35%**
2011	$1 million	$1 million	$1,060,000 plus inflation adjustment	55%
* Additional 5% surcharge applies to estates between $10 million and $17.184 million. **After 2010, the gift-tax rate will be equal to the highest income-tax rate for individuals.

 

 

       

A.     For a two (2) year period beginning on January 1, 2004, the Federal estate tax exemption (unified credit equivalent) is $1.5 million.

 

B.     January 2004 marks the beginning of the end of the unified Federal estate and gift tax structure.

 

 

V.      STRANGI III^[1] AND DISCOUNT-MOTIVATED FLPS AND FLLCS

 

A.     The (Bad) Facts.  Shortly before Mr. Strangi’s death, his son-in-law, acting under a power of attorney, transferred 98% of Mr. Strangi’s wealth, including his residence, to Strangi Family Limited Partnership (“SFLP”).  The transfer left Mr. Strangi with insufficient assets to pay his ongoing expenses.  After the transfer, Mr. Strangi continued to reside in his residence without payment of rent (although two and a half years after his death, his estate did reimburse SFLP for rent).  Partnership assets were distributed to pay for the transferor’s personal expenses.  While the other partner received compensating adjustments (mainly in the form of book entry adjustments), Mr. Strangi’s personal needs were the impetus for all distributions. 

 

                At the time of transferor’s death, Mr. Strangi owned all of the 99% limited partnership interests and 47% of Stranco, the company holding the 1% general partnership interest.  The balance of Stranco was owned by transferor’s family members (owning 52%) and a charity (owning 1%).  Stranco, as managing general partner, had sole discretion to control distributions from SFLP.  Mr. Strangi and his four children, as the sole directors of Stranco, hired Strangi’s son-in-law / attorney-in-fact to manage Stranco.  The values for Mr. Strangi’s interests in SFLP and Stranco, as reported on his Federal estate tax return, reflected a discount of over 40% from the value of the underlying assets owned by SFLP.

 

B.     The Holding.  On remand from the 5^th Circuit, which directed the Tax Court to consider the I.R.S. 2036 arguments, the Tax Court ruled that 100% of the assets transferred to SFLP by Mr. Strangi were includible in his gross taxable estate under both I.R.C. § 2036(a)(1) and §2036(a)(2).

 

C.     The §2036(a)(1) discussion.  §2036(a)(1) requires the inclusion of transferred property where decedent retained possession or enjoyment of, or the right to income from, the property.  The IRS has had previously success under §2036(a)(1) when “bad facts” were present.  See, Murphy Est. v. Comr., T.C. Memo 1990-472; Schauerhamer Est. v. Comr., T.C. Memo 1997-242; Reichardt Est. v. Comr., 114 T.C. 144 (2000); Harper Est. v. Comr., T.C. Memo 2002-121. 

 

D.     The §2036(a)(2) discussion.  §2036(a)(2) requires the inclusion of transferred property where the decedent retained the right, alone or in conjunction with another, to designate the person(s) who shall possess or enjoy the transferred property or the income therefrom, including the right to accumulate and withhold income.

 

1.     The estate argued that Mr. Strangi retained no legally enforceable rights vis-à-vis the transferred property and relied upon U.S. v. Byrum[2] for the proposition that the because Mr. Strangi’s direct and indirect managements powers were limited by fiduciary obligations, they should not cause estate inclusion. 

 

2.     The Tax Court stated Byrum “provides no basis for ‘presuming’ that fiduciary obligations will be enforced in circumstances divorced from the safeguards of business operations and meaningful independent oversight.”

 

3.     In distinguishing Byrum, the Tax Court noted the following independent constraints on decedent’s ability to control distributions that were present in Byrum were not present here:

 

        a.     Independent, third-party control over the distributions.

 

b.     Business “vicissitudes” and economic realities that could dictate distribution decisions.

 

c.      Independent, unrelated co-owners that could be expected to enforce fiduciary duties.

 

E.     The estate tried to invoke the “adequate consideration” exception to §2036(a), arguing that Mr. Strangi’s transfer of assets to SFLP in exchange for membership interests was a bona fide sale.  The Tax Court rejected this argument, characterizing the transaction as a mere “recycling of value.”

 

F.      Planning in the Aftermath of Strangi III.  It remains to be seen whether Strangi III will survive appeal or whether the IRS will attempt to use it as a basis to pull previously transferred assets back into an estate even where there are no “bad facts” present.  In the interim, to reduce the risk of §2036(a) applying, not only must a family-owned entity be properly formed and managed (i.e., no “bad facts”), but at least one of the three “independent constraints” cited by the Strangi III court should be present.  It may not be possible or desirable for a FLP or FLLC to have independent oversight (via an independent, third-party manager or third-party co-owners with substantial interests) or to be subject to business exigencies (i.e., by operating an actual business).  Note, however, that one of the key elements present in Byrum but lacking in Strangi, was the “buffer” of an independent trustee.  Query whether the result in Strangi III would have been different if at least a portion of Mr. Strangi’s limited partnership interests been transferred to an irrevocable trust, administered by an independent trust, for the benefit of Mr. Strangi’s children and descendants?

 

          VI.    REVISIONS TO THE CONNECTICUT SUCCESSION TAX

 

Summary.  The Connecticut Succession Tax was initially scheduled to be repealed incrementally over a nine year period that began in 1997 by increasing the exemption amount applicable to each class of beneficiaries.  The repeal period has since been extended.  As the law currently stands, the Connecticut Succession Tax will be fully repealed as of January 1, 2008.

 

A.     Transfers to Spouse.  Unlimited marital deduction is available at all times on transfers to spouses.

 

B.     Exemption Amount Applicable to Transfers to Children and Other Lineal      Descendants.  Phase out is complete.

                               

   Calendar                        Exemption

Year of Death                    Amount

      1996                           $  50,000

      1997                           $250,000

      1998                           $500,000

      1999                           $800,000

      2000                           $2 million

      2001 and later            unlimited

 

C.     Exemption Amount Applicable to Transfers to Brothers, Sisters and Their Descendants.  Phase out began by increasing exemption amount to $200,000 in 1999.  Phase-out is complete in 2006.

 

   Calendar                        Exemption

Year of Death                    Amount

      1998                           $       6,000

      1999                           $   200,000

      2000                           $   400,000

      2001-2004*                $   600,000*

      2005                           $1,500,000

      2006 and later            unlimited

 

                *Note, for taxpayers dying in January and February 2003, the exemption amount is $1,500,000.

 

        D.     Exemption Amount Applicable to Transfers to Unrelated Noncharitable         Beneficiaries.  Exemption increases to $200,000 in 2001.  All transfers are    exempt beginning in 2008.

 

   Calendar                        Exemption

Year of Death                    Amount

      2000                           $       1,000

      2001 – 2005*             $   200,000*

      2005                           $   400,000

      2006                           $   600,000

      2007                           $1,500,000

      2008 and later            unlimited

 

                *Note, for taxpayers dying in January and February 2003, the exemption amount is $400,000.

 

VII.   REVISIONS TO THE CONNECTICUT ESTATE TAX

 

        Summary.  With the repeal of the Succession Tax, the Connecticut Estate Tax applies more frequently to estates in Connecticut.  The amount of the tax is the credit given by the Federal Government for state death taxes paid. 

 

A.     Phase out of the Credit at the Federal Level.  Beginning on January 1, 2002, the Federal Government is phasing out the state death tax credit allowable to estates for purposes of calculating the amount of Federal estate tax due:

 

1.     For estates of decedents dying in 2002, the state death tax credit will be 75% of its current amount.

 

2.     For estates of decedents dying in 2003, the state death tax credit will be 50% of its current amount.

 

3.     For estates of decedents dying in 2004, the state death tax credit will be 25% of its current amount.

 

4.     The state death tax credit will be repealed for estates of decedents dying after December 31, 2004.

 

B.     Because the repeal of the state death tax credit will result in a significant loss of revenue for the states, many states have revised or are considering revising their estate tax laws so they are “decoupled” from the Federal state death tax credit. The estate tax laws of states that have decoupled vary.  However, in general, these states now calculate their estate tax by ignoring, in some measure, the increases to the Federal unified credit and the decreases to the Federal state death tax credit that have taken place since January 1, 2002.

 

1.     Decoupling in Connecticut.  The Connecticut Estate Tax is scheduled to be temporarily decoupled from the Federal state death tax credit for six months.  Effective for decedent’s dying July 1, 2004 through December 31, 2004, the Connecticut Estate Tax is computed by:

 

a.     Limiting the unified credit to $1,000,000;

 

b.     Ignoring the state death tax credit reductions for Federal estate tax purposes: and

 

c.      Increasing the amount arrived at by 30%.

 

In addition, for decedents dying from July 1, 2004 through December 31, 2004, the Connecticut Estate Tax will be due six months (rather than nine months) from date of death.

 

Note:  This temporary decoupling of the Connecticut Estate Tax is only scheduled to take place if Connecticut does not receive $110 million in Federal Medicaid funds for the 2004-2005 fiscal year.  However, given the ongoing budget crises faced by the State, it is likely that, at some point in time, the Connecticut Estate Tax will be permanently decoupled from Federal law.

 

2.     De-Coupling in Other States – A Sampling.  Some 16 states (other then Connecticut) have de-coupled their estate taxes from Federal law.

 

a.     Rhode Island and New Jersey.  The estate tax in these states equals to the maximum state death tax credit allowed under federal law as it existed prior to the 2001 Tax Act ignoring the scheduled increases in the unified credit scheduled to take place under prior law.  As a result, the unified credit equivalent in Rhode Island and New Jersey is permanently limited to $675,000.

 

b.     Massachusetts, New York, and Vermont.  These three states also tie their estate tax to the state death tax credit under Federal law as it existed prior to the 2001 Tax Act.  However, these states do take into effect the increases in the unified credit scheduled to occur under prior law.  Accordingly, in these states, the unified credit equivalent will be $700,000 for decedent’s dying during 2003; $850,000 for decedent’s dying during 2004; $950,000 for decedent’s dying during 2005; and $1,000,000 for decedent’s dying during 2006 and thereafter.  Note, the laws in these states have different effective dates.

 

 

c.      Florida.  The Florida estate tax structure can only be revised via an amendment to the Florida Constitution.  As it currently stands, Florida estate taxes will be phased out along with the Federal state death tax credit.

 

C.     In all cases, an estate may deduct the amount of Connecticut Succession Taxes paid from the amount of Connecticut Estate Taxes otherwise due.

 

VIII.        FREEZE IN CONNECTICUT GIFT TAX EXEMPTION

 

A.     The Connecticut gift tax exemption was initially scheduled to be increased to $1,000,000 over a six year period beginning with the 2001 calendar year.  As with the phase-out of the Connecticut Succession Tax, the scheduled increases in the Connecticut gift tax exemption have been temporarily “frozen,” with the  increases now scheduled to be complete in 2010:

 

      Calendar                     Exemption

      Year of Gift                  Amount

      2001-2005                  $     25,000

      2006                           $     50,000

      2007                           $     75,000

      2008                           $   100,000

      2009                           $   950,000

      2010                           $1,000,000

 

B.     In addition to the exemption amounts listed above, the Federal annual gift tax exclusion of $11,000 per person continues to apply to present interest gifts.  For example, no Connecticut gift tax will be due on a present interest gift of $36,000 from a single donor to one person in year 2003. Remember, however, the “cliff effect” that results if the amount gifted in the preceding example was $36,001 (Connecticut gift tax of $250.20 would be due).

 

C.     Rate of tax ranging from 1% to 6% applies to gifts that exceed the exemption amount.  Remember, Connecticut gift tax will continue to apply beyond 2010 for gifts of more than $1.0 million!

 

 

IX.    RECENT CHANGES TO CONNECTICUT MEDICAID (TITLE XIX) LAW

 

A.     As of October 1, 2003, an institutionalized spouse applying for Medicaid (Title XIX) and having a spouse living in the community shall be required, to the maximum extent permitted by law, to divert income to such community spouse in order to raise the community spouse’s income to the Minimum Monthly Needs Allowance, prior to allowing the community spouse to retain assets in excess of the Community Spouse Protected Amount.

 

B.     Connecticut Public Act 03-3 includes a provision that any transfer of assets resulting in the establishment or imposition of a penalty period creates a debt due and owing by the transferor or transferee to the Department of Social Services in an amount equal to the amount of the medical assistance provided to the transferor on or after the date of the transfer of assets, but not to exceed the fair market value of the transfer.  In order to enforce this provision, the statute grants the Commissioner of Social Services, the Commissioner of Administrative Services and the Attorney General the power or authority to seek administrative, legal or equitable relief as provided by other statutes or common law.  Although the statute is ambiguous regarding the effective date of this provision, the prevailing thought among practitioners is that it will not be effective unless the waiver discussed in Section C below is approved.

 

C.     On April 26, 2002, the Connecticut Department of Social Services, as required by Public Act No. 01-2, submitted to the Centers for Medicare and Medicaid Services a proposal seeking a waiver of Federal Medicaid (Title XIX) laws.  If approved, the waiver would result in:

 

1.     delaying the start of the penalty period as a result of gifts made by the applicant from the month a gift is made to the month the applicant is otherwise found eligible for Title XIX benefits; and

 

2.     extending the three (3) year look-back period to five (5) years for transfers involving real property.

 

The waiver contains a proposed implementation date of October 1, 2002.  However, since the implementation date has passed and the waiver has not yet been approved, it is unclear what the implementation date will be if the waiver is approved.

 

X.      MISCELLANEOUS

 

A.     Termination of Small Trusts.  Public Act 03-183 amended Connecticut General Statute Section 45a-484, increasing from $40,000 to $100,000 the maximum value of a trust which a probate court may terminate if:  (i) the court finds that it is uneconomical or not in the best interests of the beneficiaries to continue the trust; and (ii) termination of the trust is equitable and practical. 

 

B.     Sample Qualified Personal Residence Trust.  The Internal Revenue Service recently issued Revenue Procedure 2003-42 which contains a sample declaration of trust for a Qualified Personal Residence Trust (“QPRT”) with one transferor for a term equal to the lesser of the life of the term holder or a term of years.  The form also includes samples of certain alternative provisions.  The IRS will recognize a trust as a QPRT meeting all of the requirements of Section 2702(a)(3)(A) and Section 25.2702-5(c) of the Treasury Regulations if the trust instrument is substantially similar to the sample form or if the trust instrument properly integrates one or more of the alternative provisions and the trust is a valid trust under applicable local law.