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Welcome to the State of Tennessee

Important Points for Residents | No Estate Tax for 2010
Income Limit Lifted on ROTH IRA Conversions
Early Social Security | Alternative Minimum Tax

Important Points for Tennessee Residents

There are a few important income and estate/gift tax aspects for residents of the state that you need to know.

Income Tax (Form INC-250) (Often referred to as the Hall Tax)

While the state does not have an income tax based on a person's earned income, it does have a tax on interest and dividends received. Not all of the dividends and interest are taxable. The current tax rate is 6% and individuals can exclude up to $1250 ($2500 married and filing jointly).  Elderly persons (65 and over) with total income less than $16,200 single ($27,000 joint) are exempt from filing and paying this tax.

Inheritance Tax (Form INC-301)

While the federal estate tax has disappeared for one year, the State of Tennessee continues to exempt only one million ($1,000,000). Therefore, an estate can be nontaxable at the federal level but taxable to the State of Tennessee. The tax rate is graduated, starting at 5.5% and increasing to 9.5%.

Gift Tax (Form INC-300)

The state imposes a tax on gifts and the rate of tax is affected by the type of beneficiary. Unlike the federal gift tax that uses a unified credit to reduce the tax on gifts, the State of Tennessee has no such credit and therefore it is possible that the donor will owe state gift tax, but no federal gift tax.

Gifts to family members (lineal descendents) (class A) in excess of the annual exemption (currently $13,000) are taxed at rates from 5.5 to 9.5%. Non-Family members (class B) in excess of $3000 are tax at rates from 6.5 to 16.0%. The dollar amounts taxable at these various rates differ substantially depending upon the type of recipient.

Should you have questions regarding your financial situation as a resident of Tennessee, please feel free to contact us for a complimentary discussion.

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No Estate Tax for 2010

The federal estate tax has disappeared for one year only due to the failure of Congress to pass a permanent extension of the law in effect for 2009.  With the expiration of the federal estate tax, there is no automatic step up in tax basis of inherited assets.  It is possible that a law will be passed in 2010 extending the estate tax retroactive to January 1, 2010.  Hence estate planning for 2010 is uncertain.

The generation-skipping transfer tax will also end for a year; however, the lifetime federal gift tax exemption remains $1 million albeit with a lower top rate of 35%.

In any event, the State of Tennessee’s inheritance tax is separate and independent from federal statutes.  The $1 million dollar threshold for taxable estates remains in effect for 2010 with regard to Tennessee residents.

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Income Limit Lifted on ROTH IRA Conversions

For 2009, the maximum yearly contribution that can be made to a Roth IRA is phased out for a single individual with modified Adjusted Gross Income between $105,000 and $120,000 and for joint filers with modified AGI between $166,000 and $176,000.  Conversion of traditional IRAs to Roth IRAs is not available to taxpayers with adjusted gross income exceeding $100,000.

Starting in 2010, there is no income limit for converting money from an IRA into a Roth IRA; however, the aforementioned income limits remain in place for direct Roth deposits.  Taxpayers who convert in 2010 can either recognize the resulting income in 2010 or split it between 2011 and 2012.  You have to elect to recognize it in 2010, and the natural inclination might be to defer the tax to 2011 – 2012.  Many tax experts anticipate that tax rates will rise in the future to help pay off America’s federal deficit with the expiration of present tax cuts which end in 2010.

The stock market downturn has also made Roth conversions attractive; many accounts have decreased in value lessening the tax burden.  Conversions are complicated and only make sense for certain taxpayers.  Are you a good candidate for a Roth conversion?  In general, there are eight reasons why a person may want to consider converting to a Roth IRA.

1. Special favorable tax attributes (e.g., charitable deduction carryforwards, net operating losses (NOLs), investment tax credits, excess itemized deductions, high basis nondeductible traditional IRAs, etc. can be utilized.
2. The required minimum distribution (RMD) rules at age 70 ½ do not apply.
3. Paying income tax on a Roth IRA conversion before paying estate tax is more tax efficient than paying estate tax first on a traditional IRA and then paying income tax on future traditional IRA distributions.
4. For those having substantial nonqualified investment sources, using these sources to pay the income tax on a Roth IRA conversion will generally enhance overall future wealth.
5. Roth IRAs are usually the best asset to fund bequests to nonspousal beneficiaries.
6. Future Roth IRA distributions are generally income tax-free to beneficiaries.
7. Converting to a Roth IRA during the joint lifetimes of married spouses is more tax efficient than taking traditional IRA distributions after one spouse dies (due to the differences between single and married filing jointly tax brackets).
8. There is an ability to “recharacterize” (i.e., undo) prior Roth IRA conversions all the way up until October 15 of the year following the year of a Roth IRA conversion.

Once you have decided it is financially desirable to convert to a ROTH IRA, there    are a number of issues you will need to review.  The ROTH IRA conversion, although seemingly tax and quantitative driven, also raises a number of legal issues that require the advice of Counsel.  A ROTH conversion raises asset protection issues, beneficiary designation issues, and estate tax apportionment issues.

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Important information for those considering taking Social Security before normal retirement age

The following is the current normal retirement age (NRA) as specified by the Social Security Administration (SSA):

If you elect to take social security benefits before your NRA, then your benefits are reduced $1 for every $2 you earn in excess of the earning limit. For 2010 the earning limit remains at $14,160.

In the year you reach NRA, the earning limit applies to the months prior to the month in which you reach NRA. Then your benefits are reduced $1 for every $3 you earn in excess of the earning limit. This limit is also more generous. For 2010 the annual earnings limit remains $37,680.

Once a person reaches NRA, there is no reduction in benefits for earnings.

The reduction identified above relates to a direct reduction in amounts of social security a person receives. Social security benefits may still be taxed up to 85% when income received by the taxpayer(s) exceeds $25,000 (single) and $32,000 (married filing jointly).

Should you take reduced benefits before your normal retirement age? That depends on several factors. To make an easy determination, please go to the following page.

http://www.metlife.com/individual/financial-tools/social-security-tool/index.html

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Alternative Minimum Tax (AMT) can be an additional burden

The alternative minimum tax was created in 1969 to make the super rich pay income tax. It requires the taxpayer to calculate the income tax liability by the conventional method and the AMT method. Taxpayers are then required to pay the higher amount of the two.

Which taxpayers are at greater risk to incur the AMT tax? Those individuals who have the following circumstances:

1. Income above $100,000
2. Substantial capital gains
3. Large families with many deductions
4. Depreciation deductions on business equipment or investment real estate
5. Domiciles requiring high state and local income taxes
6. Large miscellaneous deductions
7. Exercising incentive stock options

What are the AMT rates?

The AMT rate is 26% or 28% depending on the amount that is subject to tax. In addition, there are special rates applicable to net capital gains. The taxable amount is the amount by which your "alternative minimum taxable income" exceeds your exemption amount. AMT will hit more taxpayers in 2010. The AMT exemption amount for 2010 is $33,750 single, $45,000 married filing jointly or qualified widow(er), and $22,500 if married filing separately. For 2009, these amounts were $46,700, $70,950, and $35,475 respectively. Also for 2010 many personal tax credits cannot offset the AMT. Note, however, that the exemption amount is phased out at the rate of 25 cents for every dollar of taxable income in excess of $112,500 for single individuals; $150,000 for married couples; and $75,000 for married taxpayers filing separately.

Do corporations pay AMT?

C corporations may incur the AMT. However, small corporations with average gross receipts from the prior 3 years of 47.5 million or less are exempt. The amount drops to $5 million if the business is less than three years old.

Can anything be done to minimize the AMT?

Yes. Start planning now to avoid the AMT. We can assess your tax situation and determine if the stealth tax will get you! If so, we can assist you in minimizing and possibly eliminating this tax.

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