What is the Estate Tax and why do we have it!

Ok, so this tax seemed to be getting an awful lot of bad press lately.  Certain VERY Wealthy Think Tanks have been doing their best to get you to believe that this tax is unfair and needs to be abolished.  But does it really?

First, you need to understand exactly who and how this tax is calculated.  I’m going to be throwing a lot of numbers at you to help show how this works so try to stick with me.  Now I admit, when I was younger and not doing this for a living, I thought this was a horrible tax too, but then I learned how it worked.

The Estate Tax, intentionally misnamed the Death Tax by it’s opponents, only affects about 0.2% of the population.  Most American’s (and their heirs) will NEVER, EVER pay this tax so long as the current exemption limit stays where it is at.    In December 2010, President Obama signed the “Unemployment Insurance Reauthorization and Job Creation Act” which permanently (well, permanently until congress changes it) set the Personal Estate Tax Exclusion amount to $5,450,000 if the taxpayer is Single or $10,900,000 if married.  When a spouse passes, the spouses exemption can pass to the surviving spouse allowing the surviving spouse to take the entire $10.9M exemption in his/her estate upon their passing.

So how does this work then?  Ok… let’s say you are a single person with 1 child (this is also an important piece).  You own a house which you bought for $25,000 (it was your childhood home).   When you passed, your home was worth $200,000.  You also had the following additional assets:  Stocks worth $1,000,000 (which you paid $100,000 over your lifetime); Land purchased for $50,000 now has a Fair Market Value (FMV) of $2,000,000.

When her final tax return is completed, her Assets are Revalued at the FMV at the Date of Death.  In this example, this person’s Assets are valued at $3,200,000 with a cost of $175,000 – not too bad right.  Her assets have a GAIN of $3,025,000.   When her final tax return is done (form 1041) she will report $3,200,000 of Asset Value less the cost of $175,000 and the Capital Gain on those assets is $3,200,000 LESS the $5,490,000 exemption leaving NOTHING to tax for the Estate Tax.   Why because the FMV of those Assets is LESS than the Exemption.   Her child will inherit these assets at the FMV of those assets at the date of death and His/Her Gain on these assets (for their Final Return) starts upon their parent’s death or the date they inherited the property.

So far, this all seems fair and makes sense right.  The parent never really used or touched those assets they just stayed in some account or the parent used the home and land like they have since they purchased it.  Now let’s look at why the Anti-Estate tax people want to eliminate this.  Simply put – because they will end up paying taxes on any Gain on those assets over the Exemption Amount (remember that’s upto $11 Million).  So you’re probably saying well that’s not fair.  But wait.. here’s why it’s important.

Let’s say you are an uber wealthy Real Estate developer who has Buildings all over the world.   One building in particular you bought for only $500,000 but it’s now worth an FMV of $5,000,000.  A couple years ago you decided you wanted the Equity from that building (Equity is defined as FMV Less any loans on that Asset).   You go to the bank and take out $3,000,000 and enter into Mortgage on that building – Cash in Hand – NO TAX IMPACT ON YOUR TAX RETURN THAT YEAR but you just got $3,000,000 to spend any way you want to!!  So why no tax impact?  Because you still own the building and it’s a LOAN, something you contract to pay back.   Unexpectedly you pass away before you pay back the loan.   Now, here is why estate tax is so important.  Remember this person already received the cash equity from this building, maybe even gave some to their children but NEVER paid taxes on that $3,000,000.  By eliminating the Estate tax they never would pay taxes on it either!!  They have literally just received $3,000,000 in FREE MONEY!   Their kids could just stop paying the Mortgage and the bank takes the property… but the money, it’s gone.   The Tax Code says their children inherit the Building at the $5,000,000 FMV at the date of their parent’s death.   And let’s say they decide to just sell the building for $4,950,000 – which represents a LOSS on their taxes; the children would still end up with another $1,450,000 of TAX FREE MONEY because they sold the building at a loss and that free money, well that was part of their parent’s estate.

So what the Estate tax actually does is RECOGNIZE the PASSIVE INCOME (or Appreciation) that was locked up in ASSETS during the Taxpayers lifetime.  Think of it as a “GAP” Tax rather than an Estate or Death Tax. As this tax catches all the Passive Earnings that you’ve never been taxed on.  Most of us only get paychecks or maybe we run a small business and get Earnings from that business but that money is literally taxed every year on our tax returns.   If we are among those fortunate enough to buy Investment Assets, we still get an Exemption on that value but only when we exceed that Exemption do we pay taxes on those Investments.   Everyone gets the same exemption – EVERYONE GETS $5,490,000.

So, have I convinced you yet why having the Estate tax is Fairer than NOT having the estate tax?  And don’t take to the argument that the money was worked for…  it’s not, that money has already been taxed.  This is a tax on the PASSIVE or better yet, APPRECIATION of the asset that each of us would recognize if we sold it BEFORE we passed away… only then, it’s called CAPITAL GAIN!

I hope this helps shed some light on how this tax works.  I hope it helps explain how eliminating this allows only those seriously wealthy people to avoid paying taxes while the vast majority of us will pay tax on almost every dime we make.


Worst year EVER collecting TIN information?

Well.. Once again, we made it through the 1099 filing season without too many issues.   But it does seem that EVERY year there is one or two vendors that outright REFUSE to provide the Tax Payer Information so that you, as a business, can get your 1099s out by the January 31st filing deadline.   Having completed these information returns for over 20 years, it always surprises me when I get that one vendor that becomes belligerent about providing the information.  The first thing that pops in my head is that they don’t want the IRS or the State Revenue Department knowing that they are getting income from someone.   Now, if it’s on a personal level, the IRS doesn’t require INDIVIDUALS to issue 1099s to the Plumber, the Carpenter or the Landlord that you pay in your personal life.  But if you are a BUSINESS, in order to deduct those same expenses on your business tax return, you AS A BUSINESS, are required to issue those pesky 1099-MISCs indicating that you paid someone $600 or more during the calendar year.


So, what do you do when you encounter one of these vendors.

First and foremost – CHANGE YOUR INTERNAL POLICY!!   Make it a policy in your business that if you issue payment to ANYONE for services, that you do not issue a check until you collect the W-9 Form from them!   It’s so much easier to just tell them that your system doesn’t allow for payments to be issued UNLESS this information has been entered into the software.  And you can of coarse use the “My accountant won’t let me issue checks without this” excuse.   Let us take the heat if that’s easier.  But get the W9 form upfront!  It will also make the payee much less uncomfortable providing the info when it’s a payment they seek.  If/when you ask for that information a year later, they may not even remember doing business with you in the first place.
But ok, you’ve already paid them so now what? I typically use a 3 step process….

First attempt, I start with calling, emailing or faxing to collect the information from them.  99% of the time, this is all I need to do.  Most businesses understand that they are required to provide you with this information and don’t make a fuss about it.   Sometimes it may take 2-3 attempts, but normally they will send the information.   THAT BEING SAID… If you are the RECIPIENT… Don’t just send the W9 out because you get asked!  Be sure that you actually did do business with the Person/Business that is requesting the information.  Remember that ID thieves will try any number of methods to obtain your information so just take a bit of caution before you just send this out!!  And if, you don’t feel comfortable giving us, the accounting firm, the information, just indicate to the requester (if it’s not the business owner asking) that you gave it to your customer.  We, the accounting firm, will understand and can the get the information from our client.
Second attempt, I send another email or call indicating that if they don’t provide the information that the IRS REQUIRES the payee to withhold 28% of all payments because they failed to provide the information.  This is right on page 2 of the W9 form, and usually, this is more than enough of a deterrent for the provider to give in and provide the information – again, to the recipient… if you don’t feel comfortable giving it to someone just because they say they are an accounting firm… give it to your customer and tell the accounting firm you did so!
Third and final attempt, make my last communication much more stern.  I indicate to the recipient that this is something that they are required to do, that the IRS requires that they provide this information and if they don’t provide it, I am required to send a 1099 anyway to the IRS with the words “Refused to Provide” where the tax ID is supposed to go on the form.  Have I had to do this?  Yes unfortunately.  It amazes me to no end that someone would think that I’d waste my valuable time trying to collect something that I really truly didn’t need.   Now, back to my first step, do I get that they are being cautious when I, an outsourced accounting firm calls…. YES, but they could just give the info to their customer and let their client give it to me.   I’m good with that, just don’t outright refuse to do this!
Finally, when every attempt has failed and the supplier/vendor/service provider just outright refuses, I send the 1099 just as I indicated I would with the words “Refused to Provide” in the box labeled Recipient’s Identification number.  I then send this 1099 and a letter to the IRS explaining that this business refused to provide the tax identification number.   You may be wondering, why do I bother to do this?  I do this because the fines to my clients could be SO huge that I want to be sure that we have done everything that I am required to do to ensure that my client does not end up with the fines.  After all it wasn’t their fault that their vendor refused causing them to not have the information they needed.

Moral of the story…. Get the W-9 form before you even give them the check!  It’s so much eaiser.

16592718 - dollars with tighten belt - financial crisis 3d concept

Concerned about the Future?

So not to scare you.. ok, maybe to scare you a little bit, every time the Republican’s have had a Super Majority in American Government (House, Senate & Presidency) they have crashed the Economy.  So far in history that’s 3 for 3 or 100% of the time!  In 1907/1908 during the Banking Panics; 1928 when the GOP gained power, the Stock Market Crashed in October 1930 and created the Great Depression from 1929-1937; and finally the 2007/2008 credit crisis crash that lead to thousands losing their jobs and homes.   Honestly, there a lot of CPA’s out there keeping it neutral, but I’m thinking I’d rather go out on limb, be proactive to help people rather than reactive giving advice after the fact.  We could be headed for a fourth time in the next 2 years, some of the signs are already there (discussions about eliminating Dodd-Frank, reducing Banking Regulations, Trade rhetoric and fair pay/minimum wage) are just a few of the issues that cause alarms to go off for me.

Now I hope I’m reading the signs wrong, but I was correct about the housing crash and the indicators I saw then.  So, here’s my suggestions and you can take them for what they are worth, or not, it’s up to you.

1st, resist buying things you don’t need and pay off as much of your Credit Card debt as you can NOW! Currently your rates are protected by the Frank-Dodd Act which the GOP has whole-heartedly set out to dismantle which means we could be going back to the days of 29.99% credit card interest (that was just 8 short years ago btw).

2nd, Refinance you home if you don’t already have a low FIXED interest rate. Once you are locked in, unless you’ll need to refi for medical or other emergency reasons, you should be ok with your Mortgage with what could be another housing fiasco (again due to the Wall Street Lobbyists on the new Administration). If you have an ARM (Adjustable Rate Mortgage) refinance out of it into a Fixed Rate as soon as possible.  This will stabilize your cash flow and hold your payments steady in the event interest rates climb.  And if you are planning or buying a new home, shop for that best rate – and don’t take out more than 80% of the value of your home on the Mortgage and always find a FIXED RATE so that you can count on a steady repayment amount.  Otherwise, sit tight and enjoy your current home.

3rd, Don’t SPLURGE on spending, but don’t stop spending altogether either. Remember the economy is only sustainable if/when there is demand from consumers for products. Without demand, supplies increases, prices drop and layoffs happen which leads to less disposable income in the economy which will begin to spiral the economy into a downward spin.  This is one of the things that happened in the early 2000’s – Sunbeam comes to mind.

4th, BUY LOCAL WHENEVER POSSIBLE! One of the things that will help support our communities is to keep as much in the local economy as possible… Use SMALL LOCAL Credit Unions or Community Banks vs Large Corporate Banks (remember these guys are the ones who got drunk on Wall Street and taxpayers ended up needing to bail out). Buy American if you can’t buy local. Obviously we don’t have Car Manufacturers in all our neighborhoods but we can support other local communities by sticking to American Made goods.  This not only helps American Manufacturing plants but also helps the downstream suppliers and local businesses that depend on that plants employees.

5th, be cautious of Phantom Profits in the Stock Market.  Phantom Profits are essentially Speculative gains on the value of the Stocks and are not based on REAL earnings of an entity.  This was one of the things that happened during the Banking/Credit Crisis of 2007 where approximately 30% of some stock’s value was phantom earnings.  When the Market corrected, thousands lost their life savings.  Stick with a LONG-TERM strategy – there is no getting rich quick, but you can certainly gamble it all away overnight on something that’s not consistent and not a sound, tested long standing company.

Finally… if you have a good job with good benefits… consider whether or not now is a good time to change. Granted sometimes you can’t help it, but by keeping your life constant through the next couple years, you will have a better chance of getting through possible crises unscathed.