Better to Give

Amid all the tax uncertainty we’re facing I’ve noticed some specific suggestions of things you can do protect yourself that I thought I’d pass along.  One caveat is that this particular suggestions list is only good for people who are doing estate planning and have assets they can give now or later. 

The first set of suggestions involves planning for the worst and hoping for the best.  So the worst is that Congress doesn’t act on expiring tax provisions.  The top tax rate on capital gains jumps to 20 percent, and dividends will face a rate as high as 39.6 % up from 15% at maximum.  Next, you need to add the Medicare surtax that will kick in on investment income for high earning households.   If all this occurs in 2013, it would make sense to divest highly appreciated assets in 2012.   Waiting on Congress may mean making this decision while supposedly enjoying the week between Christmas and New Years.  The issue will be that you don’t want to be figuring out what assets are on the list and trying to do the transactions while everyone you will need to actually make this happen is on vacation.  (I’m sure your accountant will help you out regardless, but I can’t speak for your broker or attorney.)

So the suggestion is to build a plan of what would be divested, as well as when and how in doing your 2012 tax planning scenarios.  In the worst case you then are just sending an e-mail saying you are ready for the nuclear option.  While it’s not great – it’s better than the alternatives.

The other item to consider in all this is giving gifts below the gift tax threshold.  You can give up to $13,000 a year to anyone you want without hitting the gift tax. This benefit is not due to expire, and can be helpful in terms of the areas of estate taxes that are in flux.    In addition, the little gifts don’t count towards your per individual lifetime gift tax exemption.  (That stands at $5.12 million now and it’s due to drop to $1 million per person next year unless Congress takes action.)  The only caveats are that it really has to be a gift in that you have to part company with the assets.  In addition, if it’s hard to value, it should be appraised or there can be questions when settling the estate.  One other reason to consider gifts even if you don’t have a really large estate is that every state except Connecticut doesn’t tax gifts.  If that money stays in your estate, many states collect inheritance taxes at much lower thresholds than the Feds.

It's "ill-eagle"

Today’s New York Times, in between some serious news stories, carries the tale of an IRS enforcement action that would be funny if it were not true.  The heirs of art dealer Ileana Sonnabend paid quite an estate tax bill when they got the $1 billion or so art collection that she left behind.  However, they did not pay taxes on a sculptural piece by Robert Rauchenberg, because it contains a stuffed bald eagle.  As it is illegal to sell a stuffed bald eagle art appraisers valued the piece at $0 because it has no market value.  (The restriction on the sale is no joke.  In fact, the heirs can’t have custody of the piece as the former owner had to agree to keep it on exhibit in a museum as part of complying with the law around the conservation issue.)

The IRS does assess taxes on artwork based on “market value”.  In fact they even have an Art Advisory Panel that helps determine the true value of the piece.  This panel came up with a figure of about $65 million for the piece, not knowing that it couldn’t be sold.  The IRS is aware of the restriction, but has decided to assess tax because the heirs could choose to sell the piece illegally.  Which while they could do this, they actually haven’t.

The good news is this is an unprecedented case.  Lawyers interviewed for the article couldn’t cite anything that showed the IRS using a hypothetical black market value to compute a tax liability.  An example of this distinction is Al Capone.  He was sent to jail for not paying taxes on ill-gotten gains, but he had in fact gotten said gains.  The bad news is when you fight the IRS without paying up front; they keep piling on the penalties and interest. At this point the heirs’ tax bill is up an additional almost $12 million on that amount alone.  There has to be better way.