Shonsey, Placke, Maruska, & Stava, P.C.

 What's New!

At Shonsey, Placke, Maruska, & Stava, P.C., we strive to provide our clients with information on topics of late breaking interest and prepare them to maximize the advantages of new developments.   Inside you will find information of the following subjects:

Estate Planning After TRA ’97

Learning The ABCs Of The Education IRA

AMT - Don’t Let It Sneak Up On You

With estate tax rates as high as 55%, many people have felt that relief has been long overdue. Congress addressed many concerns in the area of estate and gift taxation when they passed The Taxpayer Relief Act of 1997 (TRA ’97).

One of the most talked-about provisions of TRA ’97 is the increase in the unified credit. This credit, which benefits most Americans, hasn’t seen an increase since 1987. But, TRA ’97 has changed that, increasing the credit over the next 9 years to $1 million (see chart).

Note that if the $600,000 exemption had been indexed for inflation back in 1987, it would be well over $1 million by 2006. Also of note is that the new law doesn’t contain a provision to index the exemption after the year 2006. So, while the new law makes strides in reducing estate tax on artificial appreciation resulting from inflation, it’s a long way from eliminating it.

However, TRA ’97 does provide inflation-indexing for the $10,000 annual gift exclusion. This provision allows you to make annual "gifts" of up to $10,000 to your recipient(s) of choice on a tax-free basis. Effective in 1999, the $10,000 exclusion will be increased by the inflation factor in increments of $1,000. At the current rate of inflation, the first increase in the annual gift exclusion isn’t expected until 2001 or 2002.

Perhaps one of the most intriguing and most convoluted estate tax provisions is a new $1.3 million exclusion for qualified family owned businesses and farms. This exclusion is used in combination with the unified credit. So, in 1998, when the unified credit exemption equivalent is $625,000, this exclusion is worth $675,000 (totaling $1.3 million). In 2006, this exclusion will only be worth $300,000.

The rules surrounding the exclusion are complex and the requirements can be difficult to meet. A qualifying family owned business interest must meet certain ownership requirements and comprise more than 50% of the decedent’s adjusted gross estate. The decedent (or family) must have owned and materially participated in the business for at least five of the eight preceding years and the heirs must agree to materially participate in the business for a certain period following the decedent’s death.

Only trade or business assets qualify for the exclusion - investment assets, even excess cash, would not qualify. And, if the heirs can’t keep the business running and are forced to sell, they may be charged a recapture tax plus interest.

TRA ’97 also adds a new provision which bars the IRS from revaluing a taxpayer’s prior gifts if the statute of limitations has passed (typically 3 years). Previously, the IRS could revalue a taxpayer’s gifts for estate tax purposes, even though the statute of limitations to assess additional gift tax had expired. Under the requirements of this provision, the value and nature of the gift must be disclosed to the IRS on the gift tax return.

In light of these changes, you should review all of your estate planning instruments to ensure maximum use of the unified credit. For example, if provisions in a trust document make specific reference to $600,000 rather than using language to reference the amount of the exemption equivalent, revisions will be necessary.

Now is also a good time to review your gifting programs. Because so much of the increase in the exemption equivalent doesn’t occur until 2004 and later, if you are close to exhausting your unified credit, you need to be careful. If you are planning large taxable gifts, it may be wise to hold off making the gifts until 2004. Otherwise, you could exceed the current unified credit and have to pay gift tax.

We can help you review your estate plan and gifting program to ensure maximum utilization of these provisions.

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Learning The ABCs Of The Education IRA

A recent study issued by the General Accounting Office says that tuition for a 4-year college has increased almost 300% since 1980! Concerned about taxpayers’ abilities to pay for these escalating college costs, Congress created a new tax-favored investment tool called the Education Investment Account or Education IRA (EIRA).

While a EIRA works much like a traditional IRA, it’s not a retirement savings vehicle, rather it’s to help you save for post-secondary education costs. You may not deduct your contributions to an EIRA; however, earnings on the contributions are tax deferred. And, if the distributions are used to pay for qualifying expenses such as tuition, fees, books, and some room and board, the earnings are tax-free!

Up to $500 per child per year can be contributed to an EIRA. That may not sound like much, but it can add up over time. If a couple socks away $500 every year beginning when their child is 5 years old and the EIRA earns an 8% return, they would have about $11,500 to cover their child’s college expenses. Some members in Congress are already talking about increasing the contribution limit.

Unfortunately, while the EIRA can be an attractive savings tool, it’s subject to a number of constraints. For instance, you cannot contribute to an EIRA if you and your spouse make $150,000 or more a year ($95,000 for unmarried taxpayers). However, there are no relationship restrictions on who can make a contribution to the EIRA. So if your income level is too high, you may be able to convince a grandparent, aunt and uncle, or family friend to make the contribution instead.

There are other issues as well. If you withdraw just enough money to cover your child’s education expenses, those distributions are tax-free. However, if you withdraw more than needed, the income portion of the excess distribution is subject to tax plus a 10% penalty. And, if more than $500 is contributed to a child’s EIRA in any year, the account will get hit with a 6% excise tax on the excess contributions. Contributions generally must be made in cash and before the child reaches age 18.

If there is a balance left in the EIRA after your child completes school, it can be rolled over into an EIRA for another family member. Rollovers, made in a timely fashion (within 60 days of distribution), are tax-free transactions and are not subject to the $500 a year limitation.

Once the beneficiary reaches age 30, the money has to come out. The balance can be rolled over to another family member, or the beneficiary can receive the amount as a distribution with the earnings portion subject to tax and penalties.

One of the more confusing aspects of the EIRA is how it interplays with the new education tax credits - the HOPE credit and the Lifetime Learning credit. These are nonrefundable tax credits to cover college tuition and fees. Only one of these education incentives can be used to offset education expenses incurred by any one student in any one year. With the differences in the phase-outs and the eligible expenses, choosing which incentive to use could prove difficult.

If you’re concerned about how to pay for your child’s education, let us help you find the solution that makes the grade.

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When tax time rolls around, most taxpayers don’t give much thought to the Alternative Minimum Tax (AMT). But recent tax law changes (or the lack thereof) may force more and more people to begin considering AMT.

AMT is designed to ensure that high-income taxpayers with many itemized deductions do not avoid paying their "fair" share of taxes.

Current law provides for an exemption to prevent low and middle-income taxpayers from falling under the AMT requirements ($45,000 married filing jointly $33,750 single). As a result, most middle and lower-income taxpayers are not subject to AMT. The Joint Committee on Taxation (JCT) predicts that only about 856,000 individual tax returns will pay AMT in 1998, with most of the burden falling on income levels above $100,000 (see Figure 1). However, the amount of this exemption has never been indexed for inflation. Meanwhile, other factors such as personal exemptions, standard deductions, and tax bracket break points are indexed annually. From the effect of inflation alone, the JCT estimates that by 2008, more than 8.8 million returns will be subject to AMT. Not only will more taxpayers be subject to the AMT, but many more lower and middle-income taxpayers will pay AMT, a result Congress never intended when this system was created (see Figure 2).

New tax credits may force people into AMT even more quickly. For example, the new child credit and the Hope credit reduce a taxpayer’s regular tax, but don’t reduce AMT. As a result, a portion or all of the credits may not be used.

Unless changes are made, the AMT system will catch thousands of lower and middle-income taxpayers off guard. Some members of Congress have recognized the system’s faults and are calling for AMT reform this year. Will anything happen? It’s too early in the year to tell. But keep in mind that Congress had an opportunity to address these problems when they devised last year’s tax bill and failed to do so.

In the meantime, if you’re concerned that AMT may be sneaking up on you, give us a call. We can perform the complex calculations and ensure that you aren’t caught by surprise.

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