Podcast

 

Nationwide Book Published by Aspatore Books

This report is part of The Aspatore Special Report titled Navigating Government Election Issues:

Analyzing the Potential Implications of Federal Election Results on the Legal Community.

Wendy Fitzsimons | Partner at Romer Debbas, LLP

Wendy Fitzsimons joined the firm as a partner in April 2012 coming from her own successful New York City law practice. Wendy’s areas of practice include estate and tax planning as well as real estate for international and domestic clients.

Wendy completed her LLM in taxation in September of 2011. Wendy’s tax expertise along with her corporate, real estate and estate planning background brings a unique combination of skills to the firm. She has had long time experience creating trusts, LLC’s and corporations for international and domestic clients.

Wendy was an adjunct professor of business law at CUNY, Queens College and has given numerous presentations on tax and estate planning issues to a variety of business and professional organizations.

Wendy has received numerous fellowships and academic honors. She was awarded a Unified Court System legal fellowship by the State of New York , and she began her career as a law clerk for New York Supreme Court Justice James A. Yates.

I would like to thank Preston Postlethwaite and Tim Byon for their assistance with this chapter.

CHAPTER TITLE: The Impact of the Upcoming Election on Tax Planning Attorneys and their Clients

Introduction

With the upcoming election many of my colleagues and clients have questions as to what the legislative landscape will look like in future years should we have an Obama or a Romney victory. Each candidate has proposed a budget and tax plan that would stabilize the debt and promote economic recovery. However, there lies a stark contrast in how the candidates hope to effect these changes. This chapter seeks to address and compare the candidates’ plans for economic recovery. While the focus of the chapter includes the candidates’ plan for tax reform, issues of employment, bankruptcy, and immigration are also addressed in an effort to provide a well-rounded review of the candidates’ platforms.

The Candidates’ Tax Proposals

When our clients come to us to create a will or a trust, or to get advice on planning for their financial futures, they are all concerned about minimizing tax exposure. With the sunset of the Tax Relief, Unemployment Reauthorization and Job Creation Act of 2010 (TRA) in December 2012, it is difficult to formulate exactly how the tax laws most important to our clients—estate, gift, and generation skipping transfer (GST) tax—will change in 2013 and the years to come.

Each nominee has a different outlook: a Congress that follows President Obama’s proposal will return the estate, gift, and GST taxes to 2009 levels, with a top rate of 45 percent and an exclusion amount of $3.5 million for estate and GST taxes, and $1 million for gift taxes. Portability of unused exemption amounts between spouses would also be made permanent.[1] Under Romney’s “Believe in America” platform, he proposes to do away with the estate tax altogether.[2]

As the two candidates have very different tax proposals, our clients have a lot of uncertainty in regards to their planning. To compound the issue, tax planning costs real dollars to our clients. With an uncertain tax regime, clients do not know if spending these dollars will incur the necessary tax savings to justify the expense. Certainly, for clients with tremendous wealth, the need for aggressive planning will always exist, but for younger families with between $5-10 million in assets, flexibility in tax planning is paramount.

Impacts of Proposed Changes in Health Care Taxation

Despite prudently saving and investing throughout most of their careers, many of our clients who are near retirement age, but not eligible for Medicare, are hesitant to retire for fear of losing their health insurance coverage. Those near-retirees worried about maintaining an appropriate level of coverage will now have access to health care exchanges. These health care exchanges are online marketplaces where our clients can research and select subsidized health plans that are affordable and tailored to their current or projected needs.[3]

Importantly, these health care exchanges may impact the need for Medicaid planning for some of our clients. It simply may be more cost-effective for our clients to purchase subsidized plans then to try to qualify under the Medicaid asset and resource limitations.

Clients on the other end of the financial spectrum will also be impacted by the Medicare tax. The new Medicare tax, barring any legislative action, is due to go into effect on January 1, 2013 and affects taxpayers with an Adjusted Gross Income (AGI) of over $250,000 for joint filers, $200,000 for single filers, and $125,000 for married individuals filing separately.

The 3.8 percent tax was enacted as part of the Health Care Act in March of 2010. The 3.8 percent tax provision was included by Congress as a means of paying for the reforms proposed under the health care bill. The tax applies to income not derived in the ordinary course of trade or business (i.e., interest, dividends, annuities, royalties, and rents which are not derived in the ordinary course of trade or business) and gains attributable to the sale of property held for purposes not related to trade or business. The tax excludes non-passive income from S corporations, sole proprietorships, LLCs, or partnership income, and does not apply to items which are excluded from gross income under the income tax (i.e., tax-exempt bonds, veterans’ benefits). Non-passive, or active, income is defined as income that is derived from a trade or business where there is material participation. There are a set of criteria used by the IRS in determining whether a taxpayer is a material participant but for general purposes, material participation can be characterized as working on a regular, continuous and substantial basis in the operations of the activity.[4]

Capital Gains and Dividend Issues

President Obama’s 2013 budget proposal signals significant changes in the way the wealthiest taxpayers are taxed. The proposal plans to keep the capital gains tax at 15 percent for everyone except those making more than $200,000 ($250,000 if married). For those top earners, the capital gains rate would become 20 percent and their dividends would be taxed at their income rate—up to 39.6 percent. In addition to negatively impacting stock prices in general, it is likely that the implementation of these tax hikes would significantly reduce after tax-income for those relying on dividend income, such as retired taxpayers with individual holdings.

With the addition of the 3.8 percent health care tax, a top earner could be exposed to a significantly increased composite tax burden of up to 43.4 percent on investment income. On the other hand, a Romney victory would pressure Congress to move in the opposite direction; specifically, Romney proposes a tax plan that would “eliminate taxation of capital gains, dividends, and interest for any taxpayer with an adjusted gross income under $200,000.”[5] Because a move as radical as the one the Republican nominee advocates is unlikely to be supported by Congress, the capital gains increase, coupled with the 3.8 percent health care tax, spell a significantly increased tax burden for the top earners.[6]

Legal Concerns for Clients Entering the Housing Market

Though the economy has shown signs of slow improvement, it seems likely that the Fed will keep interest rates low for the foreseeable future. In order to continue to spur whatever economic growth we have experienced since the recent recession, the Fed has projected interest rates to remain at their current lows until at least 2014. This projection by the Fed will probably remain in place regardless of who is elected President. [7]

Recently, some of the biggest banks have made strong efforts to ease the foreclosure crisis. For instance, a recent federal report has indicated that some of the nation’s largest banks have successfully provided struggling homeowners with monetary relief through refinancing and lowering of the principal of their mortgage. Congress has consistently pushed for more relief efforts since the beginning of President Obama’s tenure in office. At the end of the day, it is up to Congress to continuously review the efforts by banks such as Bank of America and JP Morgan Chase to calm the foreclosure crisis and provide assistance to homeowners who are behind on their payments. It is important to bear in mind that the banks face pressure by Congress, not by the President. That being said, it is likely that an Obama victory would probably mean more of the same—that is, more pressure from the White House to provide monetary assistance to struggling homebuyers.

Similarly, a Romney victory would not suddenly change the way Congress has thus far dealt with the banks and the foreclosure crisis in general. Romney has indicated that, if elected, he will continue to pursue solutions somewhat similar to those already advocated by President Obama.[8]

Obama and Romney agree that Fannie and Freddie should cease to exist in their current state. Although the specifics of their plans differ, both the President and the Republican nominee want to reduce the government’s role in these two entities.[9] Although the Democrats would prefer the eventual privatization of Fannie and Freddie to take a few years, Republicans would prefer if it happened immediately. If Romney is able to win in November and subsequently effect an accelerated privatization schedule, that would mean that even more mortgages would be controlled by private entities. While Congress has shown that it is committed to overseeing the resolution of the foreclosure crisis, a sudden influx of mortgages (ranging from on time to underwater) may dilute the success experienced thus far.[10]

Legal Issues Associated with the Unemployment Rate

On the issue of taxes, Romney plans to cut taxes by implementing lower and flatter tax rates, while broadening the tax base to stimulate the economy and increase jobs. An August study from the Tax Policy Center indicates the impact of Romney’s tax plan on the macro-economy will be negligible over a 10 year period. While the tax cuts can increase the incentive to work, the tax broadening measures will have the opposite effect.[11]

Obama on the other hand wants to create tax relief to start-ups and small business to create jobs and increase wages. He further proposes to remove corporate tax breaks including, but not limited to, deductions and exclusions. However, critics say that this measure has little possibility of passing, given the highly partisan nature of the measures and the election year. Even democrats have become frustrated at the administration for its lack of progress in the tax reform arena during this election.

This election may also affect unemployment benefits, as states trim those benefits in light of dwindling unemployment insurance funds. Pennsylvania, Michigan, Missouri, Arizona, and Georgia have all reduced benefits to unemployed workers. The trend seems to indicate that more states will do the same.[12]

The Obama Administration’s stance that federal unemployment benefits should be extended stands at odds not only with the depletion of states’ unemployment funds but also with the debt that many states owe Washington for money borrowed during the recession. Georgia, for example, owes over $700 million to the federal government for money borrowed, and has recently defied Washington by refusing to extend unemployment benefits to seasonally unemployed teachers, bus drivers, and other seasonal workers.

Romney, unlike other conservatives, does not want to get rid of unemployment insurance. Instead, he wants to change how unemployment insurance is delivered. Under Romney’s plan, employees would put wages into personal savings accounts they could access in the event of a layoff. Under Romney’s plan, it remains possible that employers could contribute money as well, in lieu of a payroll tax.[13]

Changes in the Bankruptcy Field

The bankruptcy field changed considerably after the passage of The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005. Signed into law under President George W. Bush in April 2005, the new law made vast changes to US bankruptcy laws by adding additional requirements to the bankruptcy filing process. BAPCPA

A recent article in CNN Money cites a National Bureau of Economic Research study[14] that found that “While the bankruptcy rate has fallen slightly since the law took effect—from a rate of 1.4 percent in 2004 to 1.3 percent last year—the average income of bankruptcy filers has increased.”[15]

This may change after the election if the newly-elected President decides to revisit the 2005 bankruptcy law. The candidates’ statements on this issue may be instructive in understanding how the bankruptcy field may change after the election.

On personal bankruptcy, President Obama’s position seems clear. He stated in 2008 that offering new bankruptcy proposals to counter the 2005 Act would “…expedite the bankruptcy process for the military and their families by exempting them from a ‘harsh means test,’ cutting ‘unnecessary paperwork’ and ‘token counseling,’ and enacting a minimum homestead exemption to help them keep a greater share of their home’s value.[16]”

While Romney has not yet made any claims on a personal bankruptcy policy, commentators have pointed to his stance on the 2008 auto bailout as a lens into his stance on personal bankruptcy. In an op-ed piece in The New York Times, Romney argued that the auto industry should be allowed to go bankrupt, stating that, “A managed bankruptcy may be the only path to the fundamental restructuring the industry needs. It would permit the companies to shed excess labor, pension, and real estate costs. The federal government should provide guarantees for post-bankruptcy financing and assure car buyers that their warranties are not at risk.”[17]

Proposed Immigration Policy Changes

An Obama victory would likely see a continued call for comprehensive immigration reform and for many of the policies that President Obama has failed to get through in his first term.

President Obama has prioritized those undocumented immigrants posing a danger to national security for deportation, and announced in June that his administration would stop deporting young illegal immigrants who entered the country as children if they meet certain criteria previously proposed under the DREAM Act (Development, Relief, and Education For Alien Minors)[18] Broadly speaking, the DREAM Act, supported by President Obama, is a proposed piece of legislation that would set the children of undocumented immigrants on the track to citizenship, given that the children have been of good moral character and graduated from high school in the United States or served in the United States military.[19]

Immigration policy under Obama has seen increases in enforcement measures. During the Obama administration, there has been a doubling of the number of Border Patrol agents on the southern border of the United States. In addition to the manpower increase, Border Patrol agents have been employing unmanned drones for intelligence collection along the border and an additional 600 miles of fencing has been laid down between the U.S.-Mexico border.[20]

President Obama has also called for stronger penalties on employers who knowingly hire undocumented immigrants and supports the use of the E-Verify employment status system. The E-Verify system is an internet-based employment eligibility system that checks I-9 employment form information with U.S. government records. If the data match, then the employee is eligible to work. If the data does not match, the employee is allowed to work until the issue is resolved, but the employer and employee must alert the appropriate agency to resolve the issue within eight government work days from the date that the employee receives a referral letter.[21]

While Romney has similarly voiced support for comprehensive immigration reform, he favors an enforcement-heavy approach to immigration and does not endorse a road to citizenship for undocumented immigrants currently in the United States.[22]

When asked in 2011 if he would repeal the DREAM Act if Congress were to pass it, Romney reiterated his position by stating, “For those that come here illegally, the idea of giving them in-state tuition credits or other special benefits I find to be contrary to the idea of a nation of law. If I am the President of the United States I want to end illegal immigration so that we can protect legal immigration. I like legal immigration.”[23] Romney has stated his intent to impose tighter oversight over employers and increase enforcement measures to make it more likely that an undocumented worker would “self-deport” for lack of work opportunities.[24]

The Impact of the National Debt

As a tax attorney, I can only advise clients on how the national debt would affect tax legislation. Otherwise, the stabilization of the national debt and the economy are forefront issues of this election. While each candidate has proposed a budget and tax plan that would stabilize the debt and promote economic recovery, there lies a stark contrast in how the candidates hope to effect these changes.

The Romney tax plan advocates general tax reform by means of lower and flatter tax rates, an across-the-board reduction in marginal rates by 20 percent, and a broadening of the tax base.[25] Romney has also proposed a reduction of federal spending as a share of Gross Domestic Product (GDP) to 20 percent by 2016 in an effort to stem the need for future tax increases.[26]

With respect to the corporate tax reform, Mr. Romney’s plan includes a reduction in the top corporate tax rate to 25 percent and a plan to move the United States to a ‘territorial system’ of corporate governance.[27] A territorial system of corporate taxation only taxes income earned in that country. This would have the effect of exempting most or all foreign income of U.S. corporations from U.S. taxation if the income is repatriated.

While the details of how the Romney tax plan will broaden the tax base and which tax expenditures will be reduced or eliminated remain unclear, the Romney plan has proposed using the Bowles-Simpson Commission plan as a starting point.

Under President Obama, tax relief would be expanded to include start-ups and small businesses in an effort to incentivize increased hiring and wages and to prevent businesses from moving operations overseas. The Obama tax plan would also implement the “Buffett Rule” which calls for a minimum tax rate of 30 percent on individuals making over one million dollars a year.[28]

On the issue of corporate tax reform, President Obama’s plan would “eliminate all tax expenditures of specific industries, with the few exceptions that are critical to broader growth or fairness.”[29] The Obama plan would also attempt to bring “greater parity between large corporations and large non-corporate counterparts.”[30] While President Obama has proposed to lower the top corporate tax rate to 28% from 35%, his plan does not include a move to a territorial corporate governance system as does Romney’s plan. Rather, a minimum tax rate would be applied to profits from a corporation’s foreign subsidiaries. Additional U.S. Taxes are applied if the taxes of the subsidiary host nation do not hit the minimum tax rate. To counter the negative effect that this plan would have on the repatriation of corporate profits, Obama’s plan offers tax credits to businesses moving operations to the United States and eliminates tax deductions for moving operations abroad.[31] Moreover, the top corporate rates would be lowered to 25% with even lower rates for “advanced manufacturing.”[32]

Commentators seem to be split on what kind of effect the candidates’ plans would have on the national debt. Some analysts state that the Obama plan would add more debt and raise deficits than would Romney’s plan due to spending on healthcare entitlements and higher tax rates. Yet similar claims about increased debt and higher deficits are being made against the Romney plan, with most of the criticism arising from the lack of specificity in the plan and the effect it may have on middle-class families.[33]

Post-Election Challenges: Advising Tax Law Clients

If President Obama wins the upcoming election, I will update my clients on the potential of lower exemption amounts associated with the federal estate, gift, and GST tax, as well as the permanency of portability. Should Romney win the election, I do not anticipate that Congress would do away with the estate tax altogether. It is likely that the exemption amounts will continue to remain high, as they do now, at 5 million for individuals and 10 million for married persons. I would also anticipate that portability would become permanent. As such, I will advise my domestic clients in a similar fashion as I do now with conservative, yet flexible estate plans that minimize their costs but also protect them should the exemption amounts decrease in future years.

For married couples with assets in the 5-7 million dollar mark this means creating wills with disclaimer trusts for state death tax, and if necessary, Federal Estate Tax. A disclaimer trust allows the surviving spouse to disclaim part of their inheritance and put that amount into a trust for their children or other beneficiaries. This structure allows the surviving spouse to reduce their taxable estate. A disclaimer trust works with an uncertain legislative future because it is optional. If the Federal estate tax is removed or if the exemption amounts remain high, the surviving spouse would simply elect not to disclaim a portion of their estate or only disclaim an amount that would reduce New York State death tax.

To add to the uncertainty, I also advise international buyers of New York real estate on a variety of tax issues including the Federal estate tax. In the unlikely chance Romney removes the Federal Estate Tax, many of the tax planning vehicles we currently use to minimize estate tax will be less of a mandate. Instead of planning around the federal estate tax, the primary concern for international buyers of foreign real estate will be on protecting themselves from liability while also obtaining capital gains tax treatment on the sale of their property. This will require the formation of an LLC, as opposed to a trust or foreign holding company owning an LLC. As a result, our planning strategies will be much less sophisticated.

As noted above, many of my clients are foreign buyers. As the New York real estate market is somewhat insulated from fluctuations in the rest of the country, I generally advise clients that New York real is a good investment vehicle. With the current economic problems in the European Union (EU), I anticipate advising more clients from European countries, including France, Greece, Italy, and Spain, who are eager to take advantage of the New York real estate market.

Conclusion

While there remains much uncertainty at this stage as to whether or not a victory by either candidate will result in the tax and economic reform they have proposed, this Chapter attempts to lay out the candidates plans for reform to highlight the benefits and drawbacks of each. While Obama’s plan for tax reform is more defined at these stages then Romney’s, Obama’s critics claim his plan is far too bipartisan to actually pass in Congress. On the other hand critics of Romney claim that his plan will have a negligible impact on the economy. The best advice I have for my clients and colleagues at this stage in planning for the upcoming changes, is to remain flexible and conservative in their tax planning, and most importantly, informed.