The Wall Street Journal reported that President-Elect Obama and congressional leaders plan to move soon to retain the estate tax at current levels.  The estate tax is a tax levied on all assets of someone who has passed away.  The tax was set to disappear in 2010, and then revert to earlier levels of an exemption of $1 million dollars and a top rate of 55%.  According to Obama’s plan detailed during the campaign:

the estate tax would be locked in permanently at the rate and exemption levels that took effect this year. That would exempt estates of $3.5 million — $7 million for couples — from any taxation. The value of estates above that would be taxed at 45%. If the tax were returned to Clinton-era levels, it would exclude $1 million from taxation with the rest taxed at 55%.

In this opinion piece also in the Wall Street Journal, the author pointed to a A 2006 Joint Economic Committee (JEC) study which pointed out that "liabilities depend on the skill of the estate planner, rather than on the capacity to pay."  The press release announcing the study is titled "New Study Documents Destructive Effects of the Estate Tax."  The study itself deals with many aspects of the effects of an estate tax, but I’ll focus on the effects it has on family businesses and entrepreneurial activity.

According to the study, a survey shows that the estate tax is the primary reason why family owned small businesses fail to survive for more than one generation.  Why is this?  Because of the lack of liquid assets needed to pay estate tax liabilities.  This is true of someone who may have a nice sized small business but not much in the way of liquid assets such as cash, stocks and bonds.  So when the estate tax bill comes around there are no funds to satisfy the bill, and a sale of the company may be forced.  Some small business owners may try to alleviate this problem by acquiring life insurance to provide their heirs with funds to pay estate taxes, but often times this is not enough.

Granted, this study was conducted when the exemption levels were lower.  A $3.5 million exemption, if Obama and congress freeze it at current levels, is better than a $1 million exemption.  However, there is no indication that there will be an inflation adjustment in any such plan.  If not, we may have a situation similar to the Alternative Minimum Tax that, when left unadjusted, snared more and more taxpayers each successive year.  So what may not be a problem now can be in just a few years, especially in light of concerns current monetary policy may trigger higher inflation in the future.

So what’s a small business owner, or anyone with substantial assets to do?  With proper planning, you can be aware of the various laws and the available tools that minimize or eliminate any estate taxes.  There are of course other benefits to developing an estate plan that do not involve the tax aspects.  But taxes remain an important piece of the conversation as long as an estate tax remains in the tax code.

It is that time of the year for employers to start mailing out tax notifications for their employees.  California has enacted a law (AB 650) requiring notification to employees that they may be eligible for an Earned Income Tax Credit, a refundable tax credit usually available for lower income workers.  As you can see in the California Employment Development Department’s FAQ, this notice should be given to all employees who receive a W-2 or 1099, regardless of their level of income.  You can comply by hand delivering or mailing to their last known address:

1. Instructions on how to obtain any notices available from the Internal Revenue Service for this purpose, including, but not limited to, the IRS Notice 797 and Form W-5, or any successor notice or form; or,
2. Any notice created by the employer, as long as it contains substantially the same language as the notice described below or in this sample notice:Based on your annual earnings, you may be eligible to receive the earned income tax credit from the federal government. The earned income tax credit is a refundable federal income tax credit for low-income working individuals and families. The earned income tax credit has no effect on certain welfare benefits. In most cases, earned income tax credit payments will not be used to determine eligibility for Medicaid, supplemental security income, food stamps, low-income housing or most temporary assistance for needy families payments. Even if you do not owe federal taxes, you must file a tax return to receive the earned income tax credit. Be sure to fill out the earned income tax credit form in the federal income tax return booklet. For information regarding your eligibility to receive the earned income tax credit, including information on how to obtain the IRS Notice 797 or Form W-5, or any other necessary forms and instructions, contact the Internal Revenue Service at 1-800-829-3676 or through its Web site at www.irs.gov.

   Employers may provide the EITC notification with or at the same time as the Form W-2 or Form 1099 is given to employees.

Interestingly enough, California does not offer their own credit, but 22 other states, the District of Columbia, and two counties do. the law as it is written does not expressly state any punishments for not complying with the law.  However, it would not be wise to count on that as a reason for not complying.

Whenever I get into a discussion about incorporating a business or organizing a Limited Liability Company (LLC), a topic that often comes up is, “what is the franchise minimum tax?”

A Corporation or an LLC being treated as a corporation are stand alone entities with separate tax concerns.  If your corporation or LLC is doing business in California, you will be responsible for a corporate franchise tax.  The California Franchise Tax Board defines Doing business in California as

actively engaging in any transaction in California for the purpose of financial gain or profit

Currently tax rates are as follows:

C corporations, other than banks and
financial corporations . . . . . . . . . . . . . . . . . . . . . . . . . 8.84%
C corporations that are banks or
financial corporations . . . . . . . . . . . . . . . . . . . . . . . . 10.84%
S corporations, other than banks and
financial corporations . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5%
S corporations that are banks or
financial corporations . . . . . . . . . . . . . . . . . . . . . . . . . . 3.5%

LLC’s electing to be treated as a corporation are subject to the 8.84% tax rate. Those that do not make that election, are not subject to any rates but are subject to the minimum annual tax. I will discuss LLC’s in more detail in a later post.

Back to the minimum tax.  It is a tax that must be paid whether your company is active, inactive, or operates at a loss.  For all intents and purposes, if you own a corporation or LLC you will be paying at least $800 to the Franchise Tax Board.  When you file your taxes, you will see an entry for this amount on your return, so if your tax liability exceeds $800 at the end of your taxable year, then the amount you owe will be reduced by the $800 you already paid.

For LLC’s not electing to be treated as a corporation, all taxes are passed through, but you will still be subject to this tax (in addition an income based fee).

Please note for any entities incorporated/organized after January 1, 2000, the minimum is waived and tax, if any, is based on income for that first year.