Why is this Topic Important to Wealth Managers? Wealth Managers are attempting to undertake end of year planning with great uncertainty as to the federal income and estate tax rates, exemptions, and credits for 2011. The popular press reported that a tax reduction compromise had been reached. And it was. But the stories left out the important caveat that this compromise may just be the beginning of the end, and not the end in itself.
Let’s just briefly consider the past ten days.
Last week House Democrats passed a “Middle Class” targeted bill extending the Bush income tax rate and capital gains rate cuts for individuals earning less than $200,000, less than $250,000 for joint filers. This proposal included returning to the pre-Bush tax rates of 36% and 39.6% for higher income earners.
The Senate Democrat in charge of the powerful Senate Finance Committee put forward to the full Senate the House Bill but with two important additions. Firstly, the Senate proposal would have reduced the maximum estate tax rate to 45% (instead of the pre-Bush 55% rate returning in 2011), while increasing the exemption amount from $1 million to $3.5 million. Secondly, the Senate bill would have repealed the expanded 1099 filing requirements (of the Health Care Reform act) that will take effect 2012.
However, a Senate majority by one party by no means ensures passage of the majority’s bills. In the Senate (but not in the House of Representatives) a minority party can block a bill via the procedural mechanism known as a “filibuster”. Most Americans learn about the filibuster from the Jimmy Stewart classic “Mr. Smith Goes to Washington”.
In brief, the filibuster mechanism can be employed by the minority party to block any bill from being presented for a vote based on simple majority. Once a filibuster has been employed against a bill by the minority, the majority must obtain 60 votes to overcome that filibuster. The majority will begin to negotiate with members of the minority party, offering incentives to change their vote in favor of the bill. Incentives may include adding provisions to the actual bill being discussed, but may instead include the majority supporting a different bill of the minority member.
Republican Senators drew a line in the sand – either the proposed bill be amended to include the extension of all of the Bush tax cuts (thus the elimination of the 36% and 39.6% rates on high income earners) or a filibuster would be employed to thwart a vote on it. The Democrats were unable to gather 60 votes to cancel out the filibuster. Thus, this Senate proposal died, and negotiations between the President’s economic team and the Republicans began in earnest.
On Monday, President’s Obama’s administration agreed to a compromise tax reduction package with the Senate Republicans. In exchange for the Republicans supporting a 13 month extension of unemployment benefits, the administration announced its support of two major concessions to the Republicans. Most importantly, the current Bush tax rates would be extended for all taxpayers for an additional two years (thus 2011 and 2012 income tax rates would remain at the current 2010 levels). Secondly, the President agreed to a two-year reduced maximum estate tax rate of 35% with a temporary increased exemption amount of $5 million.
The compromise includes several other tax reduction provisions. The one with the greatest impact on individual taxpayers is a one year tax-stimulus provision reducing by 2% the social security tax rate for employees (from 6.2% to 4.2%). In 2011, this 2% social security tax reduction will put $1,400 back in the pocket of a $70,000 earner. The application of the alternative minimum tax, it was agreed, would be held at bay for an additional two years (until 2012) so as not to apply to upper middle class taxpayers. Most importantly for business, the compromise includes the President’s proposal to allow businesses to deduct the entire cost of capital investment made in 2011, instead of using depreciation. This business investment incentive will probably accelerate capital purchases to be made next year in 2011 instead of 2012.
But will the House, and most importantly Senate, Democrats support this compromise? Will they instead and more likely demand more concessions, either in spending or different tax rates or both? If the Senate Democrats seek to amend either the extension of all the Bush tax cuts or the newly compromised 35% estate tax rate/$5 million exemption, will the Republicans resort to the filibuster again? Might the Republicans accept a higher estate tax rate for maintaining all the Bush income tax cuts?
The negotiations are off to a furious start between the parties, and within the parties (amongst the internal party factions). Stay tuned for the results and how they may impact your clients.
We invite your questions and comments by posting them below, or by calling the Panel of Experts.