The Strategist: Volume 4 Issue 3

The Strategist

3rd Quarter 1997 ---Tax Bill Alert--- Volume 4 Issue 3

In our last issue, I advised you that no tax bill had been agreed to by Congress and President Clinton. I even predicted what might be contained in the new tax law when and if it was submitted to the president.

Well, the time has come. Today, Tuesday, August 5, 1997, President Clinton signed what is known as "The Taxpayer Relief Act of 1997". There are numerous changes affecting estate, gift, and generation skipping taxes as well as many other areas of the law. This is the first of a two-part special newsletter highlighting the important provisions of the tax bill as we deem important to our area of specialization -- wealth transfer. Although the bill has been signed, the President has 5 days to line item veto certain provisions. If he vetoes any provisions in the next 5 days, we will notify you of the changes in part two of the ensuing newsletter.

The Unified Credit will be increasing. The current Unified Credit amount ($192,800) provides an equivalent exemption of $600,000 of assets that can pass free of federal estate or gift taxes. The equivalent exemption amount will increase over the next 9 years. The table below illustrates the increases:

Year	Equivalent Exemption Amount
1998	$625,000
1999	$650,000
2000	$675,000
2001	$675,000
2002	$700,000
2003	$700,000
2004	$850,000
2005	$950,000
2006	$1,000,000

If all goes according to schedule, on January 1, 2006, you will be able to make gifts during lifetime or leave at the time of your death, up to $1,000,000 in value without incurring a federal gift or estate tax. However, let me point out that the biggest increases in the Unified Credit do not occur until 2004. This bill is suppose to balance the budget by 2002. If the budget is not balanced by 2002, I expect that this will be one of the first items that is attacked and a postponement of the increases over $700,000 may occur. Therefore, I would strongly recommend that you use your additional Unified Credit as is afforded in the new tax law.

The next big change is an estate tax exclusion of up to $1,300,000 for qualified family-owned businesses. The long and short of this is a decedent can exclude the estate taxes on the first $1,300,000 of a qualified family-owned business but it includes the Unified Credit. Therefore, in the year 2007, only $300,000 would be available to exclude as value of a qualified business. The reason for this is by 2007, the Unified Credit exemption amount should be $1,000,000. The bill specifically states that the amount that can be exempt includes the Unified Credit. Therefore, this is not as big of a boost as we had hoped for.

Additionally, there are very restrictive provisions on who can and cannot use this provision. The rules are too complicated to get into in this newsletter, however, in general, the business must make up 50% of your estate including prior gifts and the business must be owned either 50% by one family, 70% by two families, or 90% by three families. Also, if the family disposes of the business within 10 years of the death of the decedent, a recapture of the tax occurs that ranges from 100% to 20% starting after 6 years. We will address this in more detail in a later newsletter.

Capital Gains Tax -- These rules are not as simple as initially thought and you must be careful to examine your holding period when you consider selling an asset. The table below illustrates the maximum tax rate imposed on the sale of appreciated property depending upon the holding period and the date sold:

Sell Date	Holding Period	Maximum Tax Rate
5/07/97 to 7/28/97	> 12 months	20%
On or after 7/29/97	> 12 months < 18 months	28%
On or after 7/29/97	> 18 months	20%
On or after 7/29/97	< 12 months	39.6%

It is very important to understand that in order to qualify for the 20% capital gains tax rate from this point on, you must hold an asset 18 months or more. The effect is an increased holding period for an asset from 12 months to 18 months to qualify for the most favorable tax treatment. There is also an opportunity to have a long term capital gains asset taxed at only 18%. The requirement for this is for the asset to be purchased on or after January 1, 2001 and held for at least 5 years. It does not appear as though the maximum 18% tax bracket would apply for assets sold prior to 2006 or for assets purchased prior to January 1, 2001.

Indexing for inflation has been a hot topic in discussions but no action was taken on capital gains indexing. However, there was a surprise for gift and GST purposes in regards to indexing for inflation. Beginning in 1999, the annual exclusion gift ($10,000 that can be gifted tax free to anyone each year) is indexed for a cost of living adjustment. The increased annual exclusion amount increases in increments of $1,000 rounded down to the lower $1,000. For example, if the cost of living adjustment increased the annual exclusion from $10,000 to $11,700, the annual exclusion for that year would only be $11,000.

The Generation Skipping Transfer Tax (GST) Exemption has also been indexed for inflation. Beginning in 1999, the $1,000,000 exemption is increased with the same cost of living adjustment but instead of increasing in $1,000 increments, this adjustment increases in $10,000 increments, again, rounded down to the lower $10,000.

Both the Annual Exclusion Exemption and the Generation Skipping Tax Exemption use 1997 as the starting point to apply the indexing. However, the first time the increased amounts can be utilized is 1999.

Annual Exclusion Gifts from a revocable trust now qualify as though made directly from the donor and will no longer be contested by the IRS if death occurs within 3 years of the date of the gift. Previously, these gifts, depending on the language in your trust, may have been included in the estate.

Some business owners may be familiar with what is known as a hardship election to pay estate taxes on their closely-held business. In general, the deceased qualified by having a large portion of his estate comprised of a closely-held business with no ability to pay and the IRS offered an installment method with interest to pay estate taxes. The estate taxes due on the first $1,000,000 of the business value were charged a 4% interest rate and the balance over the $1,000,000 in business value were charged the normal IRS interest rate. Interest was deductible to the estate or the business as the case may be. This also has been changed in the new tax law.

The 4% interest rate on the first $1,000,000 of business value has been reduced to 2%. The interest rate on the balance has been reduced to equal 45% of the normal IRS rate. While this could potentially benefit taxpayers that have no other way to pay the estate taxes on their closely-held business, one negative was included in this provision and that is that the interest is no longer tax deductible. Additionally, the $1,000,000 that qualifies for the 2% interest rate is also indexed for inflation similar to the GST increases in $10,000 increments and the changes in this portion of the bill take place beginning January 1, 1998.

Also contained within the bill are certain items that should protect taxpayers in their dealings with the IRS. One such item involves gifts. Under the new law, if the taxpayer discloses the value of a gift via the gift tax return or in a statement attached to the return in a manner necessary to apprise the IRS of the nature of the gifted item, the value of which is disclosed may not later be revalued by the IRS if the statute of limitations has expired. Generally, the statute of limitations is 3 years on gifts provided that there is not a material misrepresentation. What this will do in effect is require the IRS to either audit more gift tax returns within the 3 year statute of limitations from filing of the return or accept the value of the gift.

Finally, the Excess Distribution and Excess Accumulation Tax on qualified retirement plans (15% Success Tax) have been permanently repealed effective January 1, 1997. You might remember that the 15% excess distribution tax was suspended for the years 1997, 1998, and 1999. Unfortunately, under the Tax Act of 1996, there was no suspension of this tax that was imposed upon the death of an individual that had accumulated too large of an amount in their retirement plans. The new law eliminates the excess accumulations tax at death. Now at the time of death only estate and income taxes are due on retirement plan assets. Under the previous law, there were cases where a decedent's family would stand to inherit less than 20% of retirement plan assets with the balance going to the government in the form of various taxes. Under the new tax law, it appears as though the largest amount of taxation that can occur is approximately 65% versus the previous 80+%.

In our next newsletter, we will give you more highlights of the new tax bill as well as point out how to take advantage of the new provisions to benefit you and your family. If you have questions in the meantime, please do not hesitate to contact us by telephone, letter, or e-mail.

As many of you know, we tend to be busier during the last 5 months of the year as we wind up planning for our clients and this year is no exception. If you are an existing client and feel that your planning needs to be updated or would like to find out personally how the new tax bill will impact you, we encourage you to contact us as soon as possible to arrange a meeting.

To our prospective clients interested in implementing new strategies to leverage the new tax bill provisions, several meetings will probably be required. It is impossible for us to implement year-end planning without a workable time frame. Again, we would like to encourage you to give us as much notice as possible so that we may accommodate your requests.

In addition to our normal year-end client planning, we are also conducting educational seminars on estate, gift, and charitable planning under the new tax law. If you are interested in having us conduct a seminar for a qualified group in your community, your friends and peers, or an industry association, please contact me for more information.

We look forward to hearing from you.

The Wealth Transfer Group, Inc. is not engaged in the practice of law or accounting nor are any of its employees, representatives, or agents. Tax and legal advice should be obtained from qualified personnel.
(c) 1997 The Wealth Transfer Group, Inc.
283 Cranes Roost Boulevard, Suite 145, Altamonte Springs, Florida, 32701 (407) 339-5787

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