R.C. Lim, Attorney and Counselor at Law

Point - Counterpoint

A NY Times Op-Ed piece by Ray Madoff argues that there needs to be an exemption to any new estate tax for family farmers and small business owners.

Others disagree stating that it’s money that can scarcely be lost from the Treasury and that the exceptional amounts involved only include families with very large farm or business operations.

Since one of the complaints of the estate tax is that it distorts wealth distribution and encourages individuals to pursue diseconomy, this can scarcely be called a cure. Would Sam Walton’s children be permitted to take free of tax as heirs to a “family business”? On the other hand, what of a family farm in California that gainfully employs four or more heirs in comfortable but not extravagant lives? This is the complicated debate that awaits Congress after they finish bickering about Afghanistan, health care, and the environment.

Bankruptcy Filings Spike 33%

In the 3rd quarter of 2009, bankruptcies spiked 33% to 373,308 filings. Using this run rate it will be about 1.5 million over the next 12 months. Crudely, this would be about 0.5% of the overall population per year. For the 10 years it will take any current filings to drop from credit bureaus, this rate would produce around 5% of all residents showing bankruptcies. This assumes that there is no more growth in the overall rate of bankruptcy, which is unlikely. In fact, there is every reason to believe that this will not be the case since the surge will not peak until some time after the economy hits bottom. Even though this is hardly ever the best course, most people will burn through their personal savings, retirement accounts, inventory, and whatever else they can borrow, steal, or sell before they turn to bankruptcy.

Dubai World

Dubai is on the verge of bankruptcy. Two years ago, anyone might have guessed as much when it was widely reported that the city-state had 40% of the world’s cranes, used to erect skyscrapers.

The city is an architect’s paradise, is located midway between a lot of places, and is just down the road from it’s richer, petroleum-plentiful UAE neighbor, Abu Dabi. The markets shook last week because defaulting on payment is pretty much the same thing as bankruptcy. After default on a payment, any creditor can force an involuntary bankruptcy on Dubai World. Hence, headlines like the one in today’s Nouvelle Observateur, “Dubai Is at the Edge of Bankruptcy,” sorely miss the point. The same pain has already been felt. And the ripple, the shock-wave that emanates from a default such as this one, is being teased out by the thousands of sell-side analysts around the world.

The reason for this is that banking is a house of cards. When one entity fails, it puts in jeopardy all of the successive entities down the line. In this case, Dubai World owes money to a bunch of mostly European banks who are weakened by the loss of the Dubai World’s anticipated cash flows. This means that these banks 1. eat into their reserves and/or 2. likely stop new lending and must 1. raise new capital and/or 2. boost deposits from some other means.

Harder hit are probably the non-banks who do business with Dubai World. This list would include the various global construction companies and countless other entities that have signed contracts or worse extended trade credit to Dubai World. All of these many companies must now be brought into question and have had their liquidity positions carefully examined to make sure that they can withstand the shock of this loss.

The Big Question: Will the Estate Tax Disappear?

Now that it’s November and Congress is still putzing around in committee, the question of whether Congress will find enough time to pass a new estate tax bill is an open question.

As I have pointed out, failing to act will create a perverse incentive to die in 2010 so that an estate can pass tax free. Perhaps the legislators have a hard time grasping that tax policy could affect such an important decision, but I have had heard enough sick and elderly joke about this to know that it is only some people peoples’ minds.

Failing to act will also make hay of the current system that balances the bite of a steep estate tax (45%) with the benefit of a stepped-up basis. Property received at death prior to 2010 will receive the basis step up, while property received in 2010 will not. On the other hand, the accounting burden here is no different than what the service and people routinely already choose to accept when they create GRATs, QPRTs, and FLPs.  Still, there is an important difference when a person chooses, or can choose this benefit, versus cases where it is not chosen. Under current law, a family must balance the benefit of locking in the value of the asset versus the benefit of date-of-death step-up in tax basis. The decision is either made or not made.

My concern and belief is that most will attempt to wait out the uncertainty and only later will discover that many vehicles that might have saved their heirs from a big, nasty, and resurgent estate tax. In a recent WSJ article, another estate planner shares the same concern, stating simply “I would advise anyone who wants to do a GRAT or Family Limited Partnership to do it soon, like yesterday.” There are two simple reasons for this. The first is that the country is unlikely to forgo tax revenues in a time of growing deficits.  The second is that the populist sentiment in this country that should arise as a backlash from the economic crisis has only just started to be felt. The political climate will soon change to disfavor the wealthy, and there is no more glaring symbol of Bush’s Gilded Age than the nonexistent estate tax.

Goldman Sachs Apologizes

Goldman Sachs issued an apology yesterday for its role in the crisis. Evidently feeling that reparations were due, they also promise to implement some kind of $500 million “plan” that will help small businesses. The plan is still hazy on details except to include that Buffett will have some role.

As I have mentioned, small business–those most devastated by the crisis–and the real engine of the US’s economic power, comprising a whopping 50% of US GDP, have largely been ignored during the crisis. The recent failure of CIT Group, previously the largest originator of SBA loans, is but one example of this phenomena.

To state the obvious, $500 million is nothing compared to the enormity of the problem. Two simple things to get an economic recovery underway are simple. Earth to Obama: we need a federal jobs program, and it needs to start immediately. In fact, most would simply settle for a jobs plan. The second equally obvious point is that we need someone-something-anything to be actively lending to small businesses. Failure to do so means that worthwhile projects are not pursued, that potential economic growth is lost, and most importantly, that no new jobs growth occurs.

Consider this. A business has seen its extended credit lines shrink. Even if sales are stable, the business in question would certainly refrain from hiring and possibly might even be actively laying off its employees, even though its business seems stable, from a fear that it might not survive a rough month or quarter of declining sales. I believe that this phenomenon is happening now.

The US economic engine might power through this trouble, or it might not. The fact that Goldman has already tossed off this mea culpa is striking. It raises the central question here: where is the populist outrage? Taxpayer dollars have bailed out the big money center banks, and the most reprehensible part of it is that the policymakers do not even have their sweet science straight.

Yesterday’s  release of a government report stating that Treasury Secretary Geithner failed to extract concessions from AIG’s counterparties when they were at the bargaining table surely ought to piss people off. This is exactly what working people in towns across the country already knew.

The same report shows that Goldman has been lying when it stated that it was protected from an AIG default. Previously Goldman had stated that the government’s bailout of AIG did not affect their position because they had completely hedged against AIG’s failure. Yesterday’s accounting shows that claim to be false and off by about $10 billion. It should hardly be a surprise that apology and $500 million reparation proposal was issued the same day on page 1 while the lie had been a page 8 story.

Qualified Personal Residence Trusts - their time is now!

What is it?

• A qualified personal residence trust, or QPRT, is an irrevocable trust set up to hold your house for a specified number of years. By transferring your house today, you can freeze the value of your home at today’s real estate prices for estate tax planning purposes. The transfer will be deemed a “gift” and will count against your gift exemption.  During the trust term, you will live in your house as before. By living in the home for that specified time, you will further reduce the amount of the gift. At the end of the term, the house will be legal property of your heirs.

An Example:

• Let’s say that I own a house worth $1 million with no mortgage.  At the peak of the market it had been worth $1.5 million, but the price has fallen back by 33%. Following the recommendation my estate planner, I transfer my house to a QPRT, naming my daughter as the sole heir and setting the term of the trust at 20 years. The value of my gift will be the $1 million the house is worth today, reduced by the amount that the enjoyment of my home for twenty subtracts from its current value. To keep the math simple, let’s say it makes the present value of my gift $666,666. This amount will count against my lifetime gift tax credit but is easily covered by that amount and so there will be no tax due at the time of the transfer. Now if I can live longer than the 20 year term, the QPRT will succeed and the house could appreciate to any amount and no additional gift or estate tax will ever be due at my death.

Factors:

• As the example hopefully makes clear, the very best time to set up a QPRT is when real estate prices and interest rates are both low. These factors ensure that the value of the gift is at its lowest.
• You need to outlive the trust term for the QPRT to succeed as a tax strategy. That is, you outlive the term. At the end of the term, you can remain in the house, but you will need to pay rent to your heir. Bear in mind that this is often a way to further reduce the estate tax burden.
• In the case of the transfer of a single family to one individual, this plan can prevent what might otherwise require your heir to sell the family home to pay the estate tax bill.
• In the case where someone has a serious illness and is facing huge hospital bills, a QPRT can help to keep the house out of reach from the hospital.

Senator Dodd Has a Great Idea

The latest Senate banking bill suggests that the Federal Reserve Bank be stripped of its regulatory powers and that those powers be consolidated in one banking regulator (not the Fed).

It’s amazing to me how few get the significance of this gesture. Listening to the news on banking regulation over the past several months has been irritating. Many suggestions in the wake of crisis have been to expand the regulatory authority of the Federal Reserve Bank. Almost all have failed to recognize that the Federal Reserve Bank already had the regulatory authority over the banks that could have prevented the crisis from happening. The issue is that they failed to exercise it.

The Federal Reserve Bank is a classic case of what public choice theorists refer to as regulatory capture. Ironically, regulatory capture is an argument that is typically harnessed against the expansion of regulatory power. The argument suggests a method by which regulatory agencies can be “captured” by the corporate interests that they are charged with regulating. Here the Federal Reserve Bank has been “captured” by the ideology of deregulation and laissez-faire banking. The now dated but still superb account of the political inner workings at the Federal Reserve Bank is William Greider’s Secrets at the Temple. The ironic part is that regulatory capture is typically used as an argument against regulatory authority.

Stating the Obvious

Elizabeth Warren states the obvious: the government bailed out the rich but left out the poor.

Credit Card Companies Get Theirs

Rates, penalties, and fees are being hiked on over 95% of all credit cards in advance of the law prohibiting these practices that goes into effect in February.

The credit card companies had lobbied that a sudden change would be too disruptive and that they would need several months of lead time to ensure compliance with the law. Lucky for them, they had bought and paid for enough Congressmen to make that argument stick. In this case, Senator Dodd, Congresswoman Carolyn Maloney (NY), and Congressman Luis Gutierrez (IL), all Democrats, were the offending parties.

Senator Reid now wants to hurry things along.

Things must be proceeding a couple months ahead of schedule because the stench from the corruption in this first bill is so disgusting that it makes even my usually steady stomach queasy.

The Real Jobless Rate

The headline news story is that the latest unemployment figure is 10.2% which supposedly sets a 26-year record.

The bad news is that the real figure is much, much worse.  One source, shadowstats.com, calculates the figure to be nearly 22%. NPR yesterday reported mid-teens, if you include discouraged workers.

The “pollyanna creep” described well in Kevin Phillip’s Harper’s article, “Numbers Racket,” is the process by which the government has through successive administrations altered the method for the tabulation of government statistics to favor the incumbent administrations. Democrat and Republican administrations alike have indulged this process of cooking the books. JFK was the inventor of the idea that “discouraged workers,” or those not actively seeking employment, were not to be included within the definition of unemployment. Nixon innovated by letting the government choose between the seasonally adjusted and seasonally nonadjusted numbers whichever was lower. Clinton redefined discouraged workers to be even more inclusive in its definition and hence the definition of unemployed is even less inclusive.

So what does the 26-year record really mean? Given the “pollyanna creep” and inconsistency in tabulating data by the Department of Labor, it probably means that the record unemployment is probably closer to fifty years or more and that real rate of unemployment is at least in the mid-teens. For reference sake, the unemployment rate topped out in 1933 at 24.9%.