A Citizens for Tax Justice Press Release summarized GE’s federal income taxes over the past decade. The press release shows that GE paid no federal income taxes from 2008-2010 and paid a federal income tax rate over the last decade of 2.3%.
A deferred tax asset is a financial accounting concept on the balance sheet that is recognized for temporary differences that will result in deductible amounts in future years and for carryforwards. A deferred tax asset is often created by a net operating loss (NOL) carryforward, which allows the company to reduce taxable income in future years. If a company believes it is more likely than not that some portion or all of the deferred tax asset will not be realized, a valuation allowance must be recognized. The idea behind a deferred tax asset created by a NOL carryforward is that the company will earn enough income in the future to use the NOL carryforward. Therefore, at the time the NOL carryforward was created the company could create a deferred tax asset because it would get the tax benefit in the future.
Two US banks are currently carrying large net deferred tax assets on their balance sheets. On their most recent 10-Ks Citigroup and Bank of America have net deferred tax assets on their balance sheets of $51.53 billion and $31.99 billion, respectively. A deferred tax asset is calculated using the current corporate tax rate. For example, if a company had a NOL carryforward of $100 in a given year, a deferred tax asset of $35 would be created, which is the future benefit the company would receive from the NOL carryforward. This future benefit is calculated by multiplying the $100 NOL carryforward by the maximum corporate tax rate of 35%. President Obama proposed a corporate tax rate reduction from 35% to 28%, which is good news for most corporations, but not for corporations with large deferred tax assets, like Citigroup and Bank of America. Instead of the future tax benefit being a deduction valued at 35%, the future tax benefit will now be 28%, and thus the deferred tax asset will now have a lower value. When these companies are forced to write down the value of their deferred tax assets they must also have a corresponding reduction to their equity on their balance sheet. The negative results of the reduction in equity would be that it would have to be disclosed because the reduction would be material, and could possibly lower the banks’ regulatory capital. Companies with large deferred tax assets on their balance sheets are not lobbying against the corporate tax rate reduction in the public, but they cannot be pleased with the potential negative consequences that will result from a corporate tax rate reduction.
The Center on Budget and Policy Priorities published a report outlining the six objectives a well-designed corporate tax reform proposal should accomplish.
- Contribute to long-term deficit reduction
- Reduce the tax code’s bias towards overseas investments
- Improve economic efficiency by reducing special preferences
- Provide more neutral treatment of corporate and non-corporate businesses
- Reduce the tax code’s bias towards debt financing
- Take specific steps to discourage tax sheltering
For the complete report see this link
The current maximum tax rate on long-term capital gains is 15%. Capital gains have received preferential tax treatment when compared to ordinary income for most of the history of the income tax. Tax rates on capital gains and ordinary income were equal only for the first nine years of the income tax and for a short time in the late 1980s and early 1990s. The maximum tax rate on capital gains has not been as low as the current 15% maximum rate created by the Bush tax cuts since 1933 when the maximum tax rate on capital gains was 12.5%. The maximum tax rate on capital gains is set to increase to 25% in 2013, unless the 2001-2010 tax cuts are extended or the healthcare act is changed.
For a graphical representation of the historical maximum tax rates on capital gains and ordinary income see this article
A Crummey trust is a vehicle that allows parents to take advantage of tax planning through the use of the annual exclusion gift while also not handing over large amounts of money to their minor children. The annual exclusion gift currently allows a person to make gifts of $13,000 each year to as many people as he or she would like. No tax is due on this amount and a gift tax return does not have to be filed, although if a married couple wants to gift-split, they will have to file a gift tax return to elect gift-splitting. A requirement for obtaining the annual exclusion status is that the gift must be a present interest, which means the recipient of the gift must have the unrestricted right to the immediate use, possession, or enjoyment of the property or the income from the property. The present interest requirement presents the problem of wanting to take advantage of the annual exclusion gift to one’s children each year, but not wanting to hand over up to $13,000 annually to a minor. The Crummey trust solves the problem by satisfying the present interest requirement for the annual exclusion gift. It satisfies the present interest requirement by creating a right to demand payment in the beneficiary. The demand right satisfies the present interest requirement because the beneficiary has the immediate right to the contributions, and it is up to the beneficiary as to whether he or she wants to demand payment.
In order to receive the desired tax effects of a Crummey trust, several requirements must be met. First, the beneficiary of the trust must receive actual notice of contributions to the trust and the right to withdraw contributions. This requirement is satisfied by having the trustee send out a letter to the beneficiary giving him or her notice of the contribution and the right to withdraw each time a contribution is made to the trust. Second, the beneficiary must have a reasonable period of time to exercise the withdrawal right. Thirty days is considered a reasonable period of time. Third, the trust must have sufficient liquid assets to satisfy any demand made pursuant to the beneficiary’s right to demand. This means the trust should not be funded with assets that are illiquid or assets that the donor does not want to be sold to satisfy a demand. Lastly, the donor cannot enter into an agreement with the beneficiary that he or she will not exercise the demand right.
This is just a brief overview of the need that the Crummey trust fills and the requirements that need to be satisfied to get the desired tax effects. Many other considerations need to be discussed before a Crummey trust is set up, such as who will be the trustee, whether a guardian should be appointed for the minor child to receive the notice from the trustee, and whether the donor trusts the beneficiary to not exercise the demand right. A Crummey trust is not for everyone, but parents or grandparents may want to consider it if they have some of these factors: 1) they want to gift large amounts of money to their children or grandchildren, 2) they have a large estate and want to reduce their estate tax, 3) they have maxed out their other college savings options and want to save more, 4) they do not trust their children or grandchildren to manage the money as young adults, and 5) they would like their children’s or grandchildren’s college fund to own alternative investments.
For related information see my post from two weeks ago on the taxation of gift bags at award shows