Year-End Tax Planning and 2011 Tax Rate Changes

Historical perspective: It’s always interesting to look back at tax rates when we are in the middle of a Congressional battle over preserving current rates or reverting to higher rates. Here are the top tax rates dating back to 1913 when the U.S. adopted an income tax.

Top Income Tax %

Year	Top % Rate		Year	Top % Rate
1913– 1915	7		1946-1951	91
1916	15		1952-1960	92
1917	67		1961-1964	77
1918	77		1965-1980	70
1919-1921	73		1981-1986	50
1922-1923	58		1987	35
1924	46		1988-1990	28
1925- 1931	25		1991- 1992	31
1932-1935	63		1993 - 2000	39.6
1936–1940	79		2001	39.1
1941	81		2002	38.6
1942	88		2003-2010	35
1944-1945	94		2011	39.5 (projected)

(1) Tax Foundation - see full rate tables at

http://www.taxfoundation.org/files/fed_individual_rate_history-june2010.pdf

For 2011, Federal tax rates will most likely increase as the tax cuts enacted in 2001 and 2003 under the Bush Administration will expire. There is, however, a political see-saw between now and the end of the year so it's still a guessing game. The worsening of the employment picture and economic news in general provides leverage for the critics of the tax increase and with mid term elections coming up in November, it’s possible that the scheduled increases will be delayed.

At this point, the momentum appears to be with the Obama Administration. New business incentives were proposed this week. That should buffer complaints that higher rates will be a drag on the economy. Tax cuts for the middle class with incomes below $200,000 for individuals or $250,000 for a married couple will also help the Obama Administration sell the higher rates on "the wealthy".

The following changes will likely occur for 2011:

Ordinary Income

·   35% bracket  will increase to 39.6%

·   33% bracket  will increase to 36%

·   28% bracket will increase to 31%

·   25% bracket will increase to 28%

·   10% and 15% will condense to 15%

·   The top tax rate on dividends will increase from

    15% to 39.6%

Capital Gains

·   Tax rate will increase from 15% to 20% (1)

Estate and Gift

                                                  2009                   2010                      2011
Top estate tax rate (2)       45%                     -0-                        55%
Exemption                       $3.5 mil.           Unlimited                $1 mil.

      Notes
(1) Rates apply to capital gain on assets held for more than one year.  Ordinary income tax rates apply to assets held for one year or less.

(2) For 2010, there is no estate tax unless Congress enacts a retroactive tax. The Bush tax cuts increased the exemption to $3.5 million in 2009, but for 2010, the estate tax went to zero. The assumption was that Congress would enact new legislation by the end of 2009. It didn’t, so the zero rate is currently in effect until 2011 when the old rates in effect prior to 2001 are re-established.

SUGGESTED ACTIONS

Corporate Bonuses

Taxpayers should plan now for a higher rate structure. Corporations will need to consider whether 2011 bonuses should be accelerated to the current year to lessen the impact on high income earning employees.

Reconsider C Corporation vs. Pass - Through Entities for Conducting Business

For owners of closely held companies, this may be the time to evaluate the benefits of using a C corporation vs. an S corporation, or a partnership or LLC for all or part of one’s business. The first $100,000 of taxable income in a C corporation results in a federal tax of $22,500 compared to $39,600 in 2011. The top personal tax rate is even higher than 40% if one considers the various phase outs on personal returns and possible self employment taxes added on.

Dividend Policy

The tax rates on qualified dividends and capital gains were “harmonized” under the Bush changes. Since 2003, the top tax rate on both dividends and long term capital gains is 15%. With respect to increasing the tax rate on dividends, the Obama Administration may need to consider several factors.

Most economists and tax strategists agree that keeping the rates on dividends and capital gains the same allows companies to better manage their dividend policy. If the tax on dividends increases by almost 25%, companies may focus more on stock buy-backs or redemptions as a preferred strategy for shareholders, subject to rules related to a reduction in ownership to qualify for capital gains treatment.

Qualified dividends eligible for the 15% rate include dividends received from foreign companies incorporated in countries where an income tax treaty exists. Investors may rethink whether owning equities in either US or foreign companies for their dividend yield, is a good strategy if the tax rates increase to 39.6%.

For companies contemplating paying a dividend in Q1 of 2011, particularly with closely held companies, the different tax rates would in most cases favor accelerating dividend payments into the current year.

For both US and foreign hedge funds where there are substantial holdings by US investors, the fund managers should encourage investee companies to accelerate dividends into the current year. This strategy also applies to funds with foreign equities that pay qualified dividends. S corporations and other closely held pass through entities with ownership in US and foreign equities are well advised to do the same.


OTHER CONSIDERATIONS

Impact on real estate strategies

Economics aside, how should one factor in the potential tax increases noted above?

• For pending sales, the seller should attempt to close the sale prior to the end of this year.
• Old rates may continue if the sale is concluded, or a contract is executed prior to the effective date of the new rates. If the current 15% rates are "grandfathered", installment payments received in future years on sales made in 2010 may qualify for the lower rates.

Economic Policy

A Bloomberg commentator brought things into perspective for middle America with the following analysis this week:

• There are over 300,000 Americans earning over $1 million per year in the US
• For the $1 million earner, higher rates will result in an increased tax of approximately $45,000, equal to the cost of a BMW Roadster convertible

Will higher tax rates really hurt the U.S. economy? We recently had the following internal debate in the firm:

·        People over the $1 million earnings threshold might not decrease their

      spending due to higher tax rates

·        The additional money raised by higher taxes can be used to reduce

      the national debt

·        If our debt decreases, our currency will be stronger

·        If our currency is stronger, we’re less vulnerable to inflation

·        Keeping inflation in check helps everyone in the economy, so spending

      will not decline

·        If the general spending and investment level is maintained, businesses

      will have time to recover which translates into jobs which is the key

      determinant for a healthy economy

However,

·        The Administration may not use the additional revenue to pay down the

      national debt

·        The 99% of Americans earning less than $1 million may alter their

      spending habits which could drive down spending and create more

      deflation

Our final conclusion: Based on Bloomberg, you may wish to "short" your BMW stock!

Best Regards,

Brian Rowbotham

COMING SOON:

TAX PLANNING STRATEGIES FOR INVESTMENT FUND MANAGERS

The Offshore Investment Conference - Shanghai 2010

Harriet Leung and Brian Rowbotham were speakers at the annual Offshore Investment Conference in Shanghai, June 9th and 10th.

Their presentation was about International Tax Planning for Asian Families.
The speakers and attendees for this year's conference came from around the globe to discuss cross border business opportunities being generated by the red hot economy in China. The following comments summarize insights into the Chinese economy from the Investment Conference, from the Shanghai World Expo which was held concurrently, and from several clients and advisors in Shanghai.

1. The Shanghai economy is booming.

The Chinese government invested U.S.$4 billion in Expo alone, and an additional U.S.$58 billion in infrastructure projects in and around the city, including significant upgrades in rail transportation.

Huge amounts of capital have been invested in security. In every Metro station, riders must send their bags through airport like x-ray machines. The government wants to insure that the City is free of any incidents while Expo is in process.

Among the local businessmen, there is a lot of pride in the economic success achieved in Shanghai in such a short time period, along with an attitude of optimism. It's a bit like the dot com period in Silicon Valley in the late 1990s. Due to inflation concerns particularly in the real estate area, there is a degree of reserve about the economy overheating. There is a constant "bubble" or "no bubble" debate in the press, both locally and internationally.

2. China is gearing up for global leadership, reflected in their seriousness about education.

While in Shanghai, the President, Hu Jin Tao unveiled the government's plan to be a center of global innovation. Billions of dollars are being invested in the local universities and think tank centers.

Education is being seen as the key to the country's future. During our stay, the papers were full of the anxiety and anticipation for the 10 million students sitting for the national exams to qualify for the top Universities. The pressure is even more intense due to the "one child" policy where parents see their own well being based on the ability of their only child to perform well in their studies.

It was unusual to see such focus on entrance exams. You don't see Americans get this excited unless it's Super Bowl week. The testing centers were all on high security alerts, metal detectors were in place to prevent cheating devices and the internet was being screened for sales of various software and hardware devices that facilitate cheating. In areas where new construction was in progress, activities would shut down so the noise factor wouldn't interfere with students in testing centers. Last year there were riots, and troops had to be brought into several testing centers to keep the parents from causing problems. The testing period passed this year without incident.

3. Doing business in China is not without its political side.

Our conference was held in the Pudong Shangri La Hotel for three days. On day two, Iran's President Mahmoud Ahmadinejad and his entourage arrived from Tehran. China has emerged in recent years as Iran's main trading partner. Its policy with respect to Iran is to push the diplomatic process rather than imposing sanctions over Tehran's nuclear program. While the Chinese voted to impose sanctions on Iran in the UN Council, both sides need each other, so the practical side of policy prevails. To Westerners, it looks somewhat duplicitous to sanction Iran and then welcome its leader, but to the Asian businessman, the practical side of politics is the approach. In China, Western attitudes in the political arena can at times seem self-righteous.

4. Hong Kong still plays a major role in Shanghai and China.

The financial infrastructure and experience of professionals in Hong Kong are still among the best in the world, giving Hong Kong the capacity to take on the fast paced growth in financial transactions. However, it would be a mistake to underestimate the desire and capability of Shanghai in particular to gain market share as their economy grows.

While Shanghai is gearing up to be a major financial center like New York, much of the financial strategy and planning is still overseen or managed by financial institutions, consultants and trust companies based in Hong Kong.

Chinese investors are still burdened by government regulations and exchange control so it's very typical to see businesses in China either affiliated with, or owned by companies that are headquartered in Hong Kong. When China based businesses expand beyond their borders, it's typically easier for such companies to move capital to the U.S. or Europe or other parts of Asia through a Hong Kong parent or affiliate company, for legal, tax and exchange control reasons. For now, Hong Kong and Shanghai are like business partners although they both compete when it comes to attracting new businesses from abroad.

5. Opportunities for U.S. business expansion are excellent for those who are careful.

The demand for U.S. products and the desire to invest into the U.S. market, and in particular, into U.S. real estate is immense. There is tremendous liquidity in China but due to exchange controls, it's challenging for locals to do a lot of investing outside China without approval from the Central Bank which is controlled by the government. For local businesses, expanding overseas is encouraged and moving capital outside of China is allowed, but for the pure investor, it's hard to do.

Exchange control constraints force much of the investible capital to go into the local stock markets, which aren't overwhelmingly popular, and into the local real estate market which continues to heat up. The government operates like the Federal Reserve in the U.S. but its financial powers are much broader. For second homes, the cash down requirement was recently increased from 40-50%, and for a time, third home purchases were not allowed in an effort to slow down the cost of real estate which is quickly pricing out most middle class people.

The government is currently implementing a number of programs to assist local companies with acquisitions in the U.S. The scale of these programs and the capital being committed is vast when compared to most economies around the world. While all this is good, we'll likely see a "controlled increase" with inbound investments into the U.S. as opposed to a flood, so the American businessman must be very patient.

Doing deals and negotiating terms are complex. Shanghainese are famous for being bargain hunters and this culture plays directly into day to day business. Caveat emptor or buyer beware is an absolute necessity to survive. Due diligence takes much more time and effort than in the U.S., but is an absolute essential ingredient to any undertaking.

International Tax & Estate Planning

Event hosted by Reed Smith LLP for San Francisco Bar Association and California Society of Certified Public Accountants members.
Brian Rowbotham spoke on International Tax and Richard Kinyon of Morrison Foerster on Estate Planning Implications. July 2010

International Tax

Estate Planning

Clueless Corporate Boards are Invisible Culprits in Company Failures

CEOs Sweet-talk their Boards; Federal Sarbanes-Oxley rules too weak to help, and Accounting Industry too timid to intervene.


In the swirl of failures that have swamped giants like AIG, Lehman Brothers, and General Motors, corporate boards of directors are too often overlooked as the major culprit in such financial debacles. Board governance is the problem. Today, boards of major financial institutions are putting companies at risk because they are lacking in competence in risk analysis. In addition, conflicts of interest keep most - if not all - boards from being the objective advisors they are supposed to be.

Today, Congressional negotiators hammered out final changes to HR 4173, the Wall Street Reform and Consumer Protection Act, passed the U.S. Senate on May 20. This 2,000-page bill, is being hailed as the way to rein in Wall Street excesses and protect the consumer. However, this bill does absolutely nothing to deal with the problem of board governance and audit committees too beholden to corporate executives. Once again, Congress goes for getting more regulation on the books instead of getting it right. What we're seeing today is Enron déjà vu that got us the Sarbanes-Oxley Act which did nothing to prevent the financial crises we're currently facing throughout the country. Congress will continue to muddle along, more interested in being perceived as taking action rather than doing something to get to the heart of the problem.

The issue of board governance is again, becoming a hot topic. It is discussed in the attached April issue of Reuter's Venture Capital Journal.

Asian American Bankers' Association

Event hosted for members and friends of the Banking Industry Tax Planing Updates for Foreigners Investing in the U.S.
Brian Rowbotham & Harriet Leung, June 2010