Article: Tax News Includes AMT Relief, Estate Tax Exemptions

December 2008

Tax News Includes AMT Relief, Estate Tax Exemptions

The estate tax exemption increases for 2009, with “spousal portability” on the front burner

The $700 billion “bailout” bill that Congress enacted on October 3, 2008, included a number of significant tax relief provisions (see Jim Schmidt’s article), including an important benefit for taxpayers who have incurred large alternative minimum tax (AMT) liabilities in the past from the exercise of incentive stock options (ISOs).

When an employee purchases employer stock in an ISO arrangement, AMT is generally triggered at the point of exercise, even though no capital gain occurs until the stock is eventually sold. This prepayment of AMT gives rise to a tax credit carryover that was designed to allow later recovery of the AMT against future regular tax. But the complicated interplay of the regular tax and AMT has effectively prevented this recovery. Taxpayers who paid AMT on ISO exercises generally found themselves with a large tax credit carryforward that could not be utilized.

In 2007, Congress took a step toward a remedy by allowing lower income filers to begin a 20%-per-year recovery of the AMT that had been paid more than three years earlier. But for taxpayers with Form 1040 income above approximately $160,000 single or $240,000 joint, this credit recovery phased out and could not be utilized.

For 2008, Congress has made two significant improvements to allow use of these AMT credit carryovers:

The high income phase-out has been removed, meaning that all taxpayers – regardless of income level – will be able to recover their older AMT payments as a current tax credit.
Eligible credit carryovers may now be recovered 50% in 2008 and 50% in 2009. Eligible carryovers continue to be defined as AMT that has been paid more than three years prior to the current year.

Example. Lori is an executive in a publicly traded company and has an ISO plan available. From 2000 to 2003, Lori exercised a series of ISOs that resulted in $120,000 of AMT tax liability in excess of her regular tax. This AMT has been sitting in carryforward status since that time, and only $10,000 has been recovered as a credit in recent years. The AMT credit relief enacted by Congress in 2007 did not benefit Lori, as her income exceeded the phase-out range. Coming into Lori’s 2008 Form 1040 is $110,000 of over-three-year-old AMT credit carryovers. As a result of the new legislation, Lori will be able to claim a $55,000 tax credit in 2008 and a $55,000 tax credit in 2009 to fully recover her old AMT prepayments. These tax credits will fully offset any regular tax or AMT that Lori incurs in 2008 or 2009, and they become refundable if the credits exceed her actual tax.

If you could benefit from larger AMT credit carryovers, it would be important to identify the amounts that can offset both 2008 and 2009 Form 1040 taxes. Those credits may let you decrease salary withholding or minimize or eliminate quarterly tax estimates.

Estate Tax Exemption Increases for 2009

In recent years, fewer estates have been subject to the federal estate tax, due to changes in the tax law increasing the federal estate tax exemption amount.

For 2008, the exemption amount is $2 million per person, with a flat rate of 45% applying to the amount of the estate in excess of $2 million. For 2009, the exemption amount will increase to $3.5 million per person, with the excess continuing to be taxed at the 45% rate. Currently, unless Congress acts, the estate tax is scheduled to expire for 2010, but it will be resurrected in 2011 with a much lower exemption amount ($1 million) and a much higher tax rate (55%).

We expect that, in 2009, Congress will continue the estate tax in its present form.

Portability of Spousal Exemptions

President-elect Obama appears to support a change in the estate tax law to allow portability of spousal exemptions. This means that if one spouse dies without having used his or her entire exemption, the surviving spouse could use that remaining exemption in addition to the surviving spouse’s exemption.

The advantage of portability is that the entire combined exemption amount ($7 million in 2009) would be available at the second death of a couple, without having to establish marital and credit shelter trusts at the first death. These trusts, which are essential today, can be complicated and costly to set up and administer. However, there may be other non-tax reasons why a family may wish to establish such a trust (e.g., protection from creditors, managing investments, holding distributions to younger heirs, dedicating funds for education, etc.).

Example. A husband and wife each owns $3.5 million of assets. In January 2009, husband dies and leaves his entire net worth to wife. There is no federal estate tax on husband’s estate because the marital deduction allows a tax-free transfer to a surviving spouse. However, wife now has an estate worth $7 million and only a $3.5 million exemption because of the current lack of portability of exemption amounts between spouses. If wife dies in December 2009, her estate can exempt $3.5 million but will be taxed at a 45% rate on the remaining $3.5 million (i.e., $1,575,000).

Portability of spousal exemptions, or a proper credit shelter trust, would have shielded the entire $7 million from any estate tax and, thus, saved the family almost $1.6 million in tax.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.