Moore Colson :: News & Resource Center

Over the last several years, Congress has gradually whittled away at the federal estate tax. This is good news for millions of Americans. But before you uncork the champagne, remember this: Even if no federal estate tax will be owed upon your death, state death tax may be due in some form.

Many states impose estate tax at a lower threshold than the federal government does. And, in response to the federal changes, states are making their own changes to ensure they continue to receive death taxes.

States benefited from coupling

To understand this dynamic, it’s important to look back at how things used to be. Before the decreases in the federal estate tax, most states used what was called a “pick-up” death tax system. Because the federal system allowed a credit for state death tax paid, these states would impose a pick-up tax equal to the allowable federal credit. The state and federal estate tax systems were coupled, with the state, in effect, collecting a portion of the tax that would have otherwise been paid to the federal government.

Changes to the federal estate tax in recent years, however, have undermined the federal-state estate tax relationship. The changes have included increases in the federal exemption amount, and, most importantly, the elimination of the credit for state death tax. As a result, many states using a pick-up system have been scrambling to rewrite their tax laws. At stake are state tax revenues, desperately needed by most states but now reduced by the tie-in to federal law changes.

Decoupling preserves tax revenues

Although states have reacted differently to the federal changes, many have “decoupled.” In other words, the states have rewritten their death tax laws so they no longer reference or tie into the current federal rules.

Some states have decoupled by imposing a tax equal to the amount of the former federal credit for state death taxes, while still recognizing the scheduled increases in the federal exemption amount. Others have gone further and established their own (lower) exemption amounts, or they have referenced the federal exemption amounts that were scheduled to be in effect before the recent changes.

At this writing, a few states have chosen to stay coupled and let their state death tax be eliminated, and some are currently limited from changing by their state constitution — but that could change.

Planning for state taxes critical

As with income tax planning, you must consider all taxing authorities when doing your estate planning. Even if you aren’t subject to federal estate tax, you may well be hit with a state death tax.

A typical example would be under a credit shelter trust. This trust is commonly used so married couples can preserve the federal estate tax exemption of the first spouse to die while assets equal to the exemption can still benefit the surviving spouse for the rest of his or her lifetime.

In a decoupled state, the state exemption may be less than the federal exemption. If you’re married, you may have to choose whether the state tax on this difference is paid at the death of the first spouse or risk paying federal estate tax on the death of the second spouse.

The state tax could be avoided upon the death of the first spouse if less than the full federal exemption amount was transferred to the credit shelter trust — although the federal exemption would not be maximized, and it’s possible that more federal estate tax would be due upon the death of the surviving spouse. Or, the credit shelter trust could be funded with the full federal exemption amount, thereby reducing the potential federal estate tax on the death of the second spouse. State tax would still be due on the exemption difference when the first spouse dies.

You may also be taxed in locations other than your state of residence. Check state laws where you own property and make sure your estate plan takes into account any differences from federal law. For instance, if you own real estate in a state that has decoupled, the property may be subject to tax if your total estate is greater than that state’s exemption amount, even if the value of your property located in the state is substantially lower than that amount.

Stay flexible and alert

Many state tax systems are currently in a state of flux, and the federal rules will most likely continue to change. To be safe, design your estate plan with some flexibility so that certain tax related decisions can be made as events unfold.

Back to top

Suffering from the high cost of workers’ compensation insurance?
4 steps to lower premiums

Today workers’ compensation may well represent business’s largest insurance cost. In most states, employers must pay workers’ compensation insurance for W-2 employees to cover the risk for occupational injury, disease and death.

While insurance requirements, terms and the basis for premiums are largely regulated by your state workers’ compensation agency, you do have some options at your disposal for reducing coverage and claim costs.

Higher risk = higher costs

To get a better handle on your workers’ compensation insurance costs, you must understand the causes behind most claims. Many accidents happen while operating heavy equipment and machinery, handling hazardous materials or driving company vehicles.

But a growing number of injuries are also linked to cumulative trauma. For example, repetitive motions or stresses, such as typing on a computer keyboard or hunching over a monitor, may produce persistent physical pain and impairment. Even eyestrain or headaches from glaring computer monitors can be claimed under workers’ compensation.

In effect, the greater the risk of injury, the greater your premium will be. But by reducing the risk of occupational injury in your workplace and the number of workers’ compensation claims filed, you may benefit from a better insurance rate or valuable discounts.

Cost-cutting opportunities

Following are four specific ways you can reduce the risk of injury in your workplace and subsequent workers’ compensation claims:

1. Make a commitment to safety. Effectively reducing the risk for work-related injuries and claims begins by integrating your company’s commitment to safety into its core business values. Support this commitment by providing employees with helpful materials that outline safety work rules and practices, such as the importance of using safety goggles when operating machinery or wearing seatbelts when driving company vehicles. Also consider establishing a task force made up of employees and managers from different areas of your operation to help identify and remedy safety hazards.

2. Classify your employees correctly. Properly classifying employee jobs is essential in determining appropriate workers’ compensation premiums. Most states use a manual produced by the National Council on Compensation Insurance as the basis for classifying workers. Thus, make sure your employees’ classifications match those used by your state. If you believe additional classifications are warranted, ask for approval via an audit by your state’s workers’ compensation rating board.

It’s also critical to maintain accurate payroll records. These are used in the classification process to help verify that premiums are correctly assessed. Implement a job cost accounting and payroll system to help track all hours worked by risk category. The system should match risk categories to job class codes. Misclassifications can result in higher premiums, because different classifications are assessed different risks and premium levels. For example, a desk job naturally poses less risk than a factory or field job.

3. Inspect working conditions. Periodically inspect your company’s building facilities to ensure a safe and healthy work environment. This may include, for example, monitoring and maintaining proper air ventilation, acceptable water quality, adequate lighting, safe storage of supplies and inventory, and clear stairwells and emergency exits, as well as servicing facility equipment, machinery and vehicles. And don’t forget to inspect smoke detectors, fire alarms, extinguishers and sprinkler systems to make sure they’re in working order. Insurers in some states may offer lower rates or discounts for maintaining safe working conditions.

4. Purchase ergonomically designed furniture and equipment. Providing employees with properly fitted equipment and tools can help reduce the risks of injury from physical stress and fatigue. For example, ergonomically designed office

chairs and computer workstations can help reduce back strain and carpal tunnel injuries. To reduce the risk of injury, train employees on how to properly use equipment and perform tasks. Also consider how you can improve work processes, rotate tasks among workers or automate certain functions.

Finally, another way to cut down on your premium costs is to pay the deductible for claims yourself. Note that some states, however, may not offer this cost-saving option.

Despite your best efforts to promote and provide a safe work environment, accidents will happen. So, it’s important to establish a return-to-work program to help rehabilitate injured employees as quickly as possible. Doing so will help lower your claims’ costs.

Feel some relief

Occupational injuries result in not only costly workers’ compensation claims but also in added costs to replace and train new workers. Taking steps to provide a safe work environment can help reduce these costs in addition to preserving worker morale and productivity.

Get the 411 on handling a 911 workplace emergency

Protecting your business from potential legal and financial claims begins with your initial response to work-related accidents. Heed these steps when an employee is injured on the job:

Provide first aid and, if necessary, call 911 immediately.
Accompany the employee to the medical treatment facility.
Notify the individual’s family or other emergency contacts.
Report the incident within the company and document in detail what happened within 24 hours.
Follow up with the individual or his or her family to monitor medical care and recovery progress.
Help the employee determine his or her eligibility for workers’ compensation coverage benefits and promptly file an accident report with your state’s agency.
Review the process for submitting claims with the employee or his or her family.

Moreover, your company’s prompt attention and show of concern are vital in helping to ensure effective care is provided for an injured employee.

Back to Top

Why lifetime giving still makes sense

There’s a popular misconception that the repeal of the estate tax by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) makes lifetime gifts unnecessary. After all, a fundamental goal of a lifetime giving strategy is to reduce estate taxes. But there are a number of tax and nontax reasons that lifetime giving should remain an integral part of your estate plan.

Traditional estate planning strategies still relevant

As things now stand, the pre-EGTRRA gift and estate tax system will be restored in 2011 — though many experts expect Congress to intervene in some way. So if you expect to live at least five more years, traditional estate planning techniques will continue to provide important tax benefits.

For example, by taking advantage of the annual gift tax exclusion (now $12,000 per recipient), you can make tax-free gifts that reduce your estate without using your exemptions. Suppose, for example, that you have three children and nine grandchildren. At $12,000 per recipient, the annual exclusion would allow you to transfer $144,000 per year tax-free — $288,000 annually if you split gifts with your spouse.

If your net worth is large enough to make estate tax liability a concern, regular annual exclusion gifts will enable you to remove large amounts of wealth from your taxable estate.

There also may be a benefit to making gifts beyond the annual exclusion amount, especially gifts of property expected to appreciate in value. For example, Joe’s estate consists of $950,000 in publicly traded stock and he has not used any of his lifetime gift tax exemption. If he gives the stock to his daughter, Lisa, there will be no gift tax payable this year. Plus, so long as Joe lives at least three years after he

makes the gift, the stock and any appreciation in its value are removed from his estate and shielded from estate taxes.

Suppose, instead, Joe keeps the stock and dies in 2011, when its value has increased to $1.5 million. The entire amount will be included in his estate. Unless Congress modifies EGTRRA, the pre-EGTRRA law will apply. If Joe’s entire lifetime exemption amount is available at his death, his estate will have to pay $210,000 in tax.

Why you should keep giving

There are important nontax reasons to make lifetime gifts, even if the estate tax is repealed permanently or the lifetime exemption amount remains at an increased level. For instance, if you own a business, you may need to begin transferring ownership to the next generation before you retire. By taking advantage of the annual gift tax exclusion and using family limited partnerships or other tax-advantaged business structures to leverage your lifetime gift tax exemption, you can achieve these goals at the lowest possible tax cost.

Another reason to give is uncertainty over the future of the estate tax. If Congress allows EGTRRA to run its course, the estate tax will be repealed for only one year. So unless you’re planning to die in 2010, lifetime gifts will continue to provide significant estate tax benefits.

Your lifetime gift tax exemption

Deciding whether to make additional gifts that use up your $1 million lifetime gift tax exemption is a harder call. On the one hand, this strategy is of limited value as long as the estate tax exemption is substantially higher than the gift tax exemption — unless your taxable estate is in excess of the estate tax exemption. On the other hand, if the pre-EGTRRA gift and estate tax system is restored, you’ll benefit by removing appreciating assets from your estate.

Complicating matters further, you also need to think about the income tax implications. Historically, assets transferred at death have received a “stepped-up” basis equal to their fair market value, so your heirs could sell the assets without triggering capital gains taxes. But when you make a gift during your lifetime, your basis carries over to the recipient. This can mean a hefty income tax bill if the assets have appreciated significantly since you acquired them.

Before EGTRRA, income taxes generated by lifetime gifts weren’t as big a concern because they were usually overshadowed by the estate tax savings. But if the estate tax is repealed permanently or if the gap between the gift and estate tax exemptions remains, income taxes will play a bigger role in estate planning. Note that, when the estate tax is repealed in 2010, the stepped-up basis for assets transferred at death is also eliminated, with certain exceptions.

The strategy of making taxable gifts is risky under the current system. Gifts in excess of the $1 million lifetime exemption may pay off if the estate tax repeal isn’t extended and you die after 2010, when the gift and estate taxes have been reunified. But if you die before 2011, or if Congress changes the law, you may end up paying gift taxes on assets that could have been transferred tax-free at your death.

Why you should stay tuned

Lifetime giving will continue to be an important planning tool. But the most effective strategies ultimately depend on the fate of the estate tax. So keep abreast of legislative developments and be prepared to quickly adapt your estate plan when the future becomes more certain.

Back to Top

Is a Roth 401(k) right for your business?

This year, your business has another benefit it can offer employees — Roth 401(k) plans. They can be a very attractive option, especially for employees who are ineligible for contributing to Roth IRAs. But they also mean additional expense and risk for you and more complex planning for your workers.

Contributions and distributions

Traditional 401(k) contributions and earnings are tax deferred — that is, employees don’t pay any income taxes until they take a distribution. With a Roth 401(k) contribution, employees pay the taxes upfront, but qualified withdrawals of contributions and earnings are tax free.

Although a Roth 401(k) is similar to a Roth IRA, there are some important differences. Most significant, there are no income limits on participation in a Roth 401(k). Singles with modified adjusted gross income (MAGI) exceeding $110,000 and joint filers with MAGI exceeding $160,000 are ineligible to contribute to a Roth IRA. But employees at all income levels can make contributions to a Roth 401(k).

Roth 401(k)s also enjoy the same contribution limits as traditional 401(k) plans: $15,000 in 2006, plus an additional $5,000 “catch-up” contribution for employees at least age 50 by year end. For 2006, Roth IRA contributions are capped at $4,000 plus a $1,000 catch-up contribution.

Distribution rules for Roth 401(k) plans are similar to those for Roth IRAs. To qualify for tax-free withdrawals, you must keep the funds in the account for at least five years. Tax- and penalty-free withdrawals are available when you reach age 591⁄2, die or become disabled. Early withdrawals are generally subject to tax and a 10% penalty on your earnings.

Unlike Roth IRAs, Roth 401(k)s don’t allow early tax-free withdrawals for first-time home purchases and are subject to mandatory distribution rules that kick in at age 701⁄2.

The employer’s perspective

Allowing Roth contributions to your company’s 401(k) plan can be a relatively inexpensive way to provide your staff with a valuable benefit, which may help

you attract and retain talent. But note that employer matching contributions may not be allocated to a Roth 401(k) account; they must be contributed to a traditional 401(k) account.

Adding this feature adds to your administrative burden. You’ll need to amend your plan to permit Roth 401(k) contributions. (Remember that employee Roth 401(k) contributions won’t reduce their wages.) You’ll also have to maintain Roth contributions in separate accounts and set up a separate accounting system to track contributions, gains and losses, and distributions allocable to those accounts.

Another potential drawback is that the Roth option adds complexity to participants’ investment decisions. Some employers fear this additional complication could cause overall plan participation to drop, potentially throwing off the percentages used to evaluate a plan’s compliance with nondiscrimination rules. (Both plans are tested together for nondiscrimination testing.) To avoid this result, educate employees about the relative merits of Roth and traditional contributions.

The employee’s perspective

The decision between pretax (traditional) and after-tax (Roth) contributions isn’t a simple one for employees. It requires them to consider:

Current and future income,
The amount of time they have until retirement, and
Current and future tax rates.

As a rule of thumb, for employees who plan to retire relatively soon, Roth contributions benefit those who expect their marginal tax rate to increase when they retire. For example, if employees believe the government will increase tax rates or their marginal rates will rise in retirement because they’ll have fewer itemized deductions, paying the tax now — rather than later — may be their best bet. But if they believe their marginal tax rate will be lower when they retire, a traditional tax-deductible contribution may be the way to go.

For employees with some time to go before retirement, a Roth 401(k) is typically more beneficial because they’ll owe no taxes ever on the earnings (if they take only qualified withdrawals) and over that period of time those earnings may be significant.

Determining the right choice

To better see how these options compare, let’s look at a simplified example. Katherine, who turns 50 in 2006, is in the 33% tax bracket. She can afford to contribute $20,000, before taxes, to her company’s 401(k) plan. The plan allows employees to choose between traditional and Roth contributions. Suppose Katherine makes a $20,000 pretax contribution to the plan and her investment earns an 8% annual return. When she retires at age 65, her investment will have grown to $63,443. If she withdraws the funds at that time, and assuming she’ll remain in the 33% tax bracket, Katherine will end up with $42,507.

If Katherine instead elects to pay the tax upfront and make a Roth 401(k) contribution, she’ll pay $6,600 in tax on the $20,000 in income, leaving $13,400 to contribute to the plan. Plus, her account will continue to grow tax-free. When she retires, her account will grow to $42,507, which she can withdraw tax-free.

As you can see, if the tax rate is constant, the choice between traditional and Roth contributions is a wash. But tax rates are anything but constant, so your employees’ decisions will require a bit of crystal-ball gazing.

Economics aside, a Roth 401(k) account offers the advantage of certainty: The entire account balance will be available to employees when they retire, regardless of what happens to the tax rates between now and then.

One effective strategy is for employees to hedge their bets by splitting their contributions between Roth and traditional 401(k) accounts. The contribution limit is an aggregate limit on elective deferrals, which means that in 2006 an employee can allocate up to $15,000 ($20,000 if age 50 or older) between both accounts.

Bear in mind that the Economic Growth and Tax Relief Reconciliation Act of 2001, which created the Roth 401(k) plan, expires in 2010. Unless Congress extends the Roth provisions, participants won’t be able to make new Roth 401(k)

contributions after 2010. But they should be able to leave their previous contributions in their accounts or roll them over into a Roth IRA.

Advantages for all

Roth 401(k)s are a great new benefit for all. Employees will have a tax-advantaged way to save for retirement and your business will have another tool to attract and retain star workers.

Back to Top