It’s a Tough Time for Tax Strategies

“I don’t think there’s anything more significant than the estate tax,” said Catharine V. Fairley, a tax planner and partner at Draper & McGinley in Frederick, Md., citing its wide implications for wills, gifts and trusts. “No one saw this coming — that they let the estate tax sunset.” Another unknown is what will happen to the large tax cuts of 2001 and 2003, enacted under President George W. Bush. The cuts produced current income-tax rates of 10 to 35 percent that are due to expire at the end of this year. While it seems a good bet that they will not be extended permanently, the Obama administration proposes to keep them in place, at least temporarily, for all but higher-income taxpayers. Individuals earning more than $200,000 — $250,000 for married couples — would revert to top-bracket rates of 36 and 39.6 percent, from today’s 33 and 35 percent. They would pay 20 percent on capital gains and dividends, instead of 15 percent. But the legislative outcome is highly uncertain. How much will Congress want to raise taxes, even on the rich, when economic recovery is so fragile and unemployment still near double digits? At the same time, the parlous state of the nation’s finances makes it likely that a variety of taxes must rise before very long. To recommend ways to cut budget deficits, the president has pledged to appoint a bipartisan panel to make recommendations, presumably after the midterm elections. “You’ve got to believe that future tax rates are going to be significantly higher than current maximum marginal rates — and that you’re going to be subject to them,” said Bruce J. Berno, president of Berno Financial Management, a financial planner in Cincinnati. And David A. Stockman, a former head of the Office of Management and Budget for President Ronald Reagan, predicted recently that “we’re going to be in the tax-raising business for the next decade.” The administration has already proposed a $90 billion “financial responsibility fee” — which some would call a tax — on banks, and reducing the value of itemized deductions and personal exemptions for the wealthy. Other possibilities that might be considered, but are rarely discussed openly, include full or means-tested taxation of Social Security benefits and applying the Medicare payroll tax to investment income. WITH the demise of the estate tax on Dec. 31, 2009, planning has become “a nightmare,” Ms. Fairley said. “It’s just limbo,” she added, until the government decides what to do about restoring the tax, which Democrats have said they support and which directly affects the existing gift tax and the way the capital gains tax is levied. “You have to wait and see” what happens, said Robert J. DiQuollo, president of Brinton Eaton Wealth Advisors in Madison, N.J. He noted the possibility of a drawn-out constitutional challenge if the estate tax were to be brought back retroactively to, say, Jan. 1. While those who sought abolition of the estate tax say it is unlikely that its repeal will be permanent, supporters of the tax don’t imagine that the exemption amount and rate will revert to the levels of 2001 — $1 million and 55 percent — when a convoluted phase-out was enacted. “Politically, that’s not feasible,” said Chuck Marr, director of federal tax policy at the Center on Budget and Policy Priorities. He supports the targets advocated by the Obama administration — a return to the 2009 regime, which would mean a $3.5 million exemption ($7 million for couples) and a 45 percent rate for larger estates. “I wouldn’t make any drastic moves” in anticipation of what might happen,” Mr. DiQuollo warned. He did suggest, though, that in coming months investors might want to “harvest” capital gains before the rate on them rises, perhaps even selling those qualifying for long-term treatment and buying them right back. The so-called wash sale rule applies only to losses.