fred-corbalisI recently listened in on a teleconference sponsored by UBS on the current tax situation and the speakers had some interesting observations about that dysfunctional group known as Congress.

It is very quiet in Washington DC after a busy summer since everyone is working on reelections for November 2nd.  Their viewpoint was that it looks like about an 80% chance that the Republicans will retake the House, but they are unlikely to retake the Senate.

The lame duck session starts on November 15th with the return of the current Congress before being supplemented/replaced by the incoming electees.  New congressmen and congresswomen will not be sworn in until January 11th of 2011.

One exception is that three Senate seats will fill immediately and influence the lame duck session since those seats involve such things as filling the vacancy of deceased Senator Byrd’s seat.  This is important as although it is a lame duck session, basic tax policy will be decided for the following year not by the new Congress but the lame duck Congress!

The big issue is the Bush tax cuts and in particular whether the top two brackets should be extended.  The “big three” —  income taxes,  capital gains, and dividends — will most likely be extended for at least one year, but maybe two years, contrary to the President’s budget.  President Obama may even veto such action, but they deemed it unlikely–could be overridden and perhaps too high a cost in terms of political capital.  Why?  Something happened this summer — a number of Democrats questioned whether  it was sensical to raise rates on the top two brackets in a recession (or whatever you want to call this post-recession misery).

There is a train wreck scenario you should know about as well but that is unlikely–no agreement by anyone could cause all brackets to go up across the board–from top to bottom.   I doubt that will happen though Congress has done worse.  If Congress did manage to let all the rates go up,  I would guess we might have a lynch mob on capital hill!  Most likely Congress will play it safe and just extend rates one more year.

With respect to estate taxes, we are most likely to see a short term fix for a year or two.  Probably very similar to  the 2009  law with an exclusion of $3.5M and a 45% estate tax rate for 2011 and then Congress will fight some more.  I guess not only is the moment of most people’s deaths unknown to them until it happens but so is the estate tax law in effect at the time as well!

What about the 2010 law?  Unlikely to have a retroactive law here unless it’s to provide relief to those who will suffer under the carry over basis regime under the new law.  Perhaps possible to allow executors to pick and choose.  However, not clear as no one is talking much about this right now and Congress is busy raising money and getting reelected.

Grantor Retained Annuity Trusts:  still keeps coming up to make minimum term of 10 years.  Clients with net worths of $7M plus should consider these as GRATs with terms of less than 10 years may be history.

What’s a body to do?

  1. Gift tax planning:  right now gift tax rate is 35%–lowest EVER.  Effectively that is a rate of 26% in comparison to estate tax.  Difficult decision for those who have used up their lifetime exclusion but for clients with net worths of perhaps $15M plus it could make sense.  However, we have to be careful here as Congress may pass a law to raise these rates retroactively so it’s best done at the very end of the year.  Personally, it turns my stomach to see anyone pay the tax now but perhaps useful as a minor part of a broader strategy.
  2. Multigenerational Planning:  there is no generation skipping tax for 2010!  So for 2010 there may be an opportunity to set up trusts that could theoretically go on forever without any additional gift or estate or generation skipping tax once they are set up.  However, the law is unclear as to how this will apply in the future.  One strategy though could be to make outright gifts to grandkids.  Unfortunately, this strategy has the drawback that the protections of trusts, including asset protection, beneficiary maturation, and divorce protection are missed.  For those who like to gamble though, this could be part of a larger strategy.
  3. Taxes:  hard to call here as to the best strategy–if you believe the rates will go up then you may want to liquidate key positions.  Also, charitable gifts may be better made in 2011 to get greater benefit from the deduction.  If you have assets that are difficult to sell it is more problematic as to what to do since you don’t have the flexibility to make last minute dispositions at the end of 2010.

So there you have it–more messiness and uncertainty–at least it’s consistent with what’s going on with the rest of the world!