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How To Address Recent Tax Changes
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Business New Haven
11/12/2001
By:
Mitchell Young
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What a difference a couple of decades make. For most of the 1980s calls for tax simplification were heard across the land.
Ironically, with the first major tax package of the new century, the 2001 Tax Reconciliation Act, which followed in the wake of budget surpluses, the concept of clarity and simplicity were abandoned in many areas.
We'll address a few changes from the IRS and the new tax code that experts believe readers should be aware of. These changes affect new IRS pension-distribution rules for 2001 and beyond, the new estate tax law and programs for addressing educational expenses.
Pension Code Change
Here the IRS has made some changes without the direct prodding of Congress that will help many taxpayers - and tax accountants as well (of course).
The required minimum-distribution rule affects anyone near retirement age as well as people receiving as part of an inheritance assets held in a retirement account. Assets in a retirement account are “intended to be retirement vehicles,” and since they accumulate tax deferred the IRS wants you to receive that money when you retire. If you had your choice you might want to leave these assets to your heirs.
To assure your compliance the IRS has two very important rules: First, you must begin taking withdrawals from a “Qualified Retirement Plan” at 70 1/2 years of age unless you are still working and are not a five-percent or more owner of the company you work for. IRAs must begin liquidation at age 70 1/2 for all.
There are IRS tables that indicate how much you must withdraw, Failure to comply results in an amazingly stiff penalty - even by IRS standards.
For example, should you be required to take $10,000 out and fail to, your penalty is $5,000 (50 percent of the amount that should have withdrawn). Of course, when you do take out the $10,000 you'll still owe the income taxes due on that amount.
There previously were several different choices (tables) to determine the amount you had to withdraw. They were based on a life expectancy yours or others, on a fixed basis or recalculated basis. The IRS tables say, “Here is how long you have to live.” If they they give you 20 years, withdraw 1/20th of your retirement account.
Another method was recalculated: Each year you checked the table for your new life expectancy and had to withdraw based on that. There were tables with spousal consideration, or for other beneficiaries.
The life expectancies used in these tables hadn't been changed for some time. The new rules use one single table in all circumstances unless your spouse is more than ten years younger than you. This single table generally produces a lower annual payout - a good deal. One caveat: An amendment to your Qualified Plan is required to allow you to take distributions based on the new rules.
Estate Taxes
Congress set out to reduce and eliminate estate taxes and we can say up-front that whether they do good for you will still require a good accountant - a very good accountant.
The intention of this new estate law is to reduce the amount of your estate subject to estate taxes.
Currently the estate tax exemption is $700,000, increasing to $1,000,000 in 2002 and scaling up to $3.5 million in 2009. In 2010, the estate tax disappears. The law, however, expires at the end of 2010 and must be renewed or the levy will revert to current law. Additionally, the maximum rate is being dropped from 55 to 45 percent by 2007.
The real issue is what you do between now and 2010 (you may not die in 2010). Traditional estate planning remains a must. Remember that the estate exemption is the amount that can be passed to heirs other than the spouse is effectively doubled if structured correctly.
Once the estate tax goes away you can pass without estate tax, we lose the “automatic step rule” which means that you can only step up assets to an heir by a total $1.3 million effectively. Keeping records now to determine the basis of assets you will pass along is imperative to estate planning.
In the passing of a business or even stock, when the heir sells he or she will have a maximum basis of only $1.3 million rather than the current situation, where the estate was taxed but the basis was current value. The government giveth and the government taketh away.
Educational Payment and Savings Plans
There are now Qualified Tuition Plans (529 programs). They had previously been called state plans as in Connecticut's CHET program, and soon (in 2004) colleges will be able to create their own plans.
Under previous Qualified Tuition Plans and education IRAs, income would grow deferred from taxes but would be taxable upon distribution to the student, presumably at their lower income rate.
Under the changes these distributions can grow tax-free and can be distributed tax-free, as long as they are used for educational purposes.
If the money is not used by the time the beneficiary is 30 years old, the parent or grandparent can transfer the account to another family member, including cousins.
Educational IRAs also grows tax -free and are not subject to tax upon distribution if used for educational purposes. In the past, only $500 per year could be put into an account. That limit has been increased to $2,000 annually. Also, a corporation or partnership can now fund educational IRAs.
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