With 2011 tax rate decisions delayed by Washington brinksmanship, financial advisers spent most of 2010 unable to answer key questions from their wealthy clients.
“It’s been extremely challenging,” said Matt Brady, Barclays Wealth Americas’ head of wealth advisory. “Uncertainty is always hard for clients—it makes it difficult to plan.”
But with the new tax law addressing rates for just two years, it may not be long until advisers and their clients face more uncertainty.
The guessing game that characterized 2010 centered around tax cuts from the Bush era, including the estate tax. The income tax cuts enacted under Bush had been slated to expire at the end of 2010, and the estate tax, which had gone to 45% in 2009 to 0% in 2010, figured to rise as high as 55% at the beginning of 2011.
What’s more, the uncertain fate of the generation-skipping transfer tax further muddied the waters. That tax applies to gifts and bequests that are made to recipients who are one of more generations removed from the giver.
On December 15, the Senate approved a $858 billion tax plan negotiated by the White House and Republican leaders. Democrats in the House of Representatives, meanwhile, reportedly expected to pass the bill quickly.
Under the compromise, the 35% individual tax bracket would be extended for two years, until 2013. The proposal also extends the capital gains and dividends rates for those in the 25% income tax bracket and above: The current 15% rate would remain in place until 2013. And the agreement would extend the estate and generation skipping taxes for two years at a 35% rate and with a $5 million individual exemption.
Despite the compromise, the need to deal with the federal deficit looms, and observers say it could result in increased taxes two years from now. In addition to that prospect, another set of new taxes is looming for 2013, notes Pam Hollinger, an Invest Financial Corp. adviser at Marquette Bank, near Chicago.
Under the new healthcare law, individuals earning at least $200,000 a year, or couples making at least $250,000 a year, will face a .9% Medicare surtax, Hollinger says. And a 3.8% tax will apply to the investment income of high-income households.
The additional income tax poses a challenge for employers, Hollinger says. “How will they know that me and my husband add up to more than $250,000?” she says. “Employers are going to have to figure out how to account for that.”
Part of Hollinger’s duties recently has been breaking the bad news to high-net-worth clients about the 3.8% investment income tax, she says.
“Many of my clients are not aware of that,” she says. “It’s been hidden in the healthcare reform bill.”
The uncertainty over 2011 tax rates has been worrisome for some high-net-worth clients, who want to make the most tax-savvy moves before the end of the year regarding everything from charitable donations to life insurance.
But advisors such as Andrew Lucking, an adviser with PrimeVest, counsel clients not to sweat the temporary uncertainty. A long-term outlook and long-term planning are more important than reading short-term tea leaves, he said.
In a mid-December interview, Lucking used capital gains rates as an example. Without a legislative compromise by the end of the year, capital gains rates would have risen just a bit, to 20%, he noted. “There’s not a reason to sell out a good, long-term investment just based on that alone,” he said. “You always want to be careful not to let the tax tail wag the dog.”
If there’s been good news for bank-based advisors regarding the tax uncertainty, it’s that for many, the wealthiest clients who stand to be affected make up a small portion of their total clientele.
For Hollinger, the discussions with such clients have been pretty straightforward.
“I’ve just been trying to calm my clients down by telling them, ‘Once things pass, we can move forward with your plans,’” she says. “I’ve been telling them that we just have to wait and see, and soon we’ll have some certainty.”
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