It seems like only yesterday the Bush tax cuts came into effect, although it was 2001.  I think back to those days when we evaluated the impact of the new law:

We were amazed at how much clients would save with the new 15 percent tax rate on long-term capital gains and qualified dividends.

Although few understand Alternative Minimum Tax (AMT), we were grateful that the higher exemption amounts wouldn’t increase this tax burden.

We were excited about the increasing estate tax exemption and marveled over the idea of estate tax repeal.

The Bush tax laws are scheduled to expire at the end of 2010, making it time for the new administration and Congress to set forth its tax policy. The Taxpayer Certainty and Relief Acts of 2009 were introduced to the Senate by Max Baucus, D-Montana, Senate Finance Committee Chairman, on March 26, 2009. The focus of the bill is permanent middle-class tax relief and more taxes for the higher income folks (with a couple of exceptions).

Specifically, the 10, 25, and 28 percent tax brackets will continue to exist along with reduced tax rates on dividends and capital gain income for taxpayers in the 28 percent or lower brackets. Taxpayers in the higher brackets will be subject to ordinary income tax rates on dividend income and 20 percent capital gains tax rates. The highest tax bracket would increase from 35 percent to 39.5 percent.

If passed, the ‘marriage penalty’ relief will become permanent, ensuring that married couples will not incur more taxes than two single persons. In addition, the following family-friendly credit provisions will be extended:

Child tax credit income eligibility threshold set at $3,000

Adoption credit of $10,000

Child care expense credit of 35 percent, up to $3,000 for one child and $6,000 for two or more children

Earned income credit increase from 40 percent to 45 percent for taxpayers with three or more children, and increased the phase-out range by $1,880.

AMT Relief is the first provision of the bill which benefits higher income taxpayers.  AMT was created in the 1980s to levy an extra tax on wealthy tax payers who benefited from certain tax loopholes. Today, it is almost impossible for the middle-to upper middle-class to avoid AMT. Clearly, this is not what the lawmakers intended. The law currently states that the AMT exemption is fixed at $33,750 for individuals and $45,000 for married-filing-jointly taxpayers. For the last few years, Congress scrambled at year-end to ‘patch’ the AMT exemption at a higher level. The bill makes permanent a $46,700 exemption for individuals and $70,950 for married-filing-jointly.  These exemptions will be indexed for inflation. For a married taxpayer, the savings could be as much as $7,266.

The bill also addresses the estate tax. Under current law, the estate and generation-skipping transfer taxes have $3.5 million exemptions and a 45 percent tax rate. The gift tax has an exemption of $1 million. In 2010, estate taxes are set to be repealed.  In 2011, the rules revert back to the law that was in effect in 2001, allowing only a $1 million exemption and assessing a 55 percent tax rate. Something has to be done! Democrats don’t want to see repeal, and both sides of the aisle prefer an exemption higher than $1 million. The bill will make 2009 law ($3.5 million exemption and 45 percent tax rate) permanent, and index the exemption amount for inflation going forward. The result is that upper middle class families should not have to pay estate taxes.

Thus far, nothing in the bill is surprising. The ‘tax relief act’ really doesn’t provide any relief at all. The bill raises taxes on high income taxpayers, and keeps the Bush tax cuts in place for low and middle-income people. However, one provision did catch me by surprise and presents an amazing opportunity for the ultra-wealthy.

Probably for the sake of simplification, the bill unifies the gift tax exemption with the estate tax and generation-skipping transfer tax exemptions at $3.5 million.  Therefore, an affluent couple can gift $7 million to their family without incurring any gift tax!  That is $5 million more than the current law allows. The new bill creates many planning opportunities for those able to transfer this level of wealth. It will be interesting to see if this portion of the bill will ultimately become law.

Kara Harmon, CPA, CFP®, AWMA®, CRPC

Kara is the professional consultant for Dave Sadler.