Sadis & Goldberg Blog

The Securities and Exchange Commission ("SEC") has made significant changes to the Form ADV and CCOs of SEC registered investment advisers must review their current disclosure items in light of these changes.  On July 21, 2010, the SEC approved changes to the check-the-box format of the Form ADV Part 2 ("ADV Part 2").  On July 28, 2010, the SEC published details regarding the amendments to ADV Part 2, and related rules under the Investment Advisers Act ("Act"), which now requires SEC registered investment advisers to provide new and prospective clients with a brochure and brochure supplements written in plain English.1  "These changes are designed to provide clients with greater information about the individuals who will provide them with investment advice," said SEC Chairman Mary L. Schapiro. "These amendments will help transform the brochure into a plain English narrative that is well-suited to serve investors' needs and describes the adviser's conflicts, compensation, business activities, and disciplinary history."2  In addition to the existing disclosure requirements, the new ADV Part 2 must now:
1.Indicate whether advisers hold themselves out as specializing in any   particular type of advisory service.
2.Disclose the total assets under management.
3.Describe how advisers are compensated for advisory services, provide a fee schedule, and disclose whether fees are negotiable.  Adviser must also describe the types of other fees or expenses, such as brokerage fees, custody fees, and fund expenses that clients may pay in connection with the services provide.
4.Disclose conflicts of interest that arise from accepting performance based fees, including conflicts of interests related to charging some, but not all, accounts a performance fee.
5.Explain that investing in securities involves risk of loss that a client should be prepared to bear.
6.Describe any material risks that are specific to a particular strategy.
7.Disclose material facts about any legal or disciplinary event that is material to a client's evaluation of the advisory business or the integrity of management personnel.3

Furthermore, advisers must provide expanded responses to certain existing disclosure items, including: (1) brokerage practices; (2) whether they participate in or have an interest in client transactions; and/or (3) whether they invest in the same securities as they recommend for clients.  Any related conflicts of interest must be described fully.
 
To assist clients in evaluating the qualification of the individuals who will be servicing their accounts, supplements to the ADV Part 2 that provide résumé-like information about such individuals, including disciplinary history, now must be delivered to new and prospective clients, in accordance with Rule 204-3 under the Act.
 
Finally, advisers must electronically file the new ADV Part 2, which will be publicly available to potential clients on the SEC's IARD website.  Most advisers will begin distributing and electronically filing the new ADV Part 2 in the first quarter of 2011 as part of their annual renewal filings, unless an event that constitutes a material change requires an updated filing before that time. 

We recommend that you review your current disclosures and conflicts of interest in light of these new requirements and contact us to discuss required amendments for your next filings. If you have any questions regarding this Alert, please contact Dan Viola at 212.573.8038 or dviola@sglawyers.com.
 
1 See, SEC Release No. IA-3060
2 See, SEC Release 2010-127 (To access SEC Chairman Mary Schapiro's Opening Statement at the SEC 
   Open Meeting regarding Form ADV Amendments, go to:
   www.sec.gov/news/speech/2010/spch07211mls-adv.htm).
3 Id. ("Investment advisers must update their clients promptly of new disciplinary events or material
   changes to an existing event.")

Note:  Change to the Definition of an Accredited Investor is Effective Immediately.   

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Financial Bill") into law. Set forth below are certain aspects of the Financial Bill which impact investment managers to hedge funds and private equity funds.  

The Financial Bill revises one of the definitions of an "accredited investor" under the Securities Act of 1933 ("1933 Act").   Specifically, in determining if a natural person is an "accredited investor" who meets the $1 million net worth test, the value of such person's primary residence must now be excluded from the $1 million net worth calculation.  Previously, a natural person's primary residence (net of any mortgage) was included in calculating a natural person's net worth.  The other definitions of "accredited investor" under the 1933 Act are currently remaining the same.  This change in definition is effective immediately.  As a result, we urge you to contact us as soon as possible as the Confidential Private Placement Memorandum and Subscription Documents for any investment funds you manage will need to be revised for this new definition of "accredited investor".  Please note that, absent further guidance from the Securities and Exchange Commission ("SEC"), we currently believe that the new "accredited investor" definition only applies to (i) new investors in your hedge funds and (ii) existing investors in your hedge funds that make an additional capital contribution.  We do not currently believe that you need to recertify existing investors in your hedge funds that are not making additional capital contributions.  Likewise, with respect to private equity funds, if an investor has already made a capital commitment to the fund, we do not believe that subsequent draw-downs of capital by the fund from such investor will require you to recertify such investor.  However, as with hedge funds, any investor that is making a new capital commitment to the private equity fund would need to meet the new definition of "accredited investor".    

Under the Financial Bill, the Investment Advisers Act of 1940 ("Advisers Act") will also be amended to require many investment advisers that are currently exempt from registration with the SEC to register.  Generally, the Financial Bill requires all investment advisers to hedge funds and/or private equity funds that manage $150 million or more in assets to register with the SEC.  Importantly, the "private adviser" exemption which many hedge fund and private equity fund managers relied upon in the past is being eliminated.  The "private adviser" exemption enabled an investment adviser to avoid SEC registration if it: (i) did not act as an investment adviser to a registered investment company or business development company; (ii) had fewer than 15 clients (counting each fund as 1 client); and (iii) did not hold itself out to the public as an investment adviser.  Please note that the SEC will need to issue additional guidance on numerous aspects of the Financial Bill relating to investment adviser registration and coordinate their efforts with various State regulators.  Unlike the change in the "accredited investor" definition set forth above, the new rules under the Advisers Act will become effective on July 21, 2011.     

If you have any questions concerning this Financial Services Alert or any related matters, please contact Lance Friedler, 212-573-8030.

                                       
 
The information contained herein was prepared by Sadis & Goldberg LLP for general informational purposes for clients and friends of Sadis & Goldberg LLP.  Its contents should not be construed as legal advice, and readers should not act upon the information in this Tax Alert without consulting counsel.  This information is presented without any representation or warranty as to its accuracy, completeness or timeliness.  Transmission or receipt of this information does not create an attorney-client relationship with Sadis & Goldberg LLP.  Electronic mail or other communications with Sadis & Goldberg LLP cannot be guaranteed to be confidential and will not create an attorney-client relationship with Sadis & Goldberg LLP.  

In this Tax Alert we spotlight the tax provisions of two pieces of legislation, one to provide new job incentives and the other to radically reform healthcare. Both laws will have major tax legislation incorporated in them.

The Jobs Act

The President has signed a dual purpose bill, the "Hiring Incentives to Restore Employment Act of 2010" or "HIRE" (the "Act"). The Act incorporates tax measures previously introduced in the "Foreign Account Tax Compliance Act" ("FATCA"). The Act creates a new and complex withholding tax system for foreign financial institutions as well as a major tax compliance burden on U.S. taxpayers who have financial assets in foreign jurisdictions. The Act also imposes withholding taxes on foreign counterparties to swaps and other transactions based on U.S. equities.

The tax measures are projected to pay for the $13 billion of incentives to businesses who hire new workers. Because the offshore account provisions appear to conflict with proposed regulations issued by Treasury regarding reporting of foreign accounts held by U.S. persons (see our Tax Alert of March 2, 2010), we urge you to follow the developments carefully. We summarize below only the FATCA provisions of the new law. In many cases, a U.S. taxpayer will be subject to make two separate information reports for the same assets and income, and for one asset class (regulated foreign investment companies), a TRIFECTA of forms will be required. Penalties of as high as 90% of the value of the accounts could apply to the U.S. taxpayer who fails to file all of these forms and report all of the income that would have been reported if the forms had been filed in a timely and correct basis.

Compliance Burdens of Foreign Financial Institutions

A foreign financial institution will be required to enter into U.S. withholding tax agreements with the Internal Revenue Service ("IRS") and to enforce account holder verification and due diligence processes the IRS requires. This is likely to include information reporting similar to what is presently required on Form 1099. If the foreign financial institution does not comply and is unable to produce a withholding agreement with the IRS, every U.S. payor must collect a 30% withholding tax. If the foreign financial institution is compliant but the customer is not, the institution must collect the 30% U.S. tax on the "recalcitrant" customer. A "recalcitrant" customer is defined as any customer of the foreign financial institution who fails to comply with the U.S.-based requests for information about whether that customer is a U.S. taxpayer. The Act has no dollar value thresholds so that compliance costs can easily exceed any amount of U.S. taxes that may be due.

This new withholding tax regime is effective for payments made after December 31, 2012. Given the sweeping outline of the new regime and its extraterritorial scope (requiring foreign persons with no direct contact with the U.S. to enforce the U.S.'s income tax system) the effective date may well prove unworkable. The IRS has a great deal to get done by January 1, 2013 if taxpayers are to implement this new system, as the law leaves many critical elements to be defined by regulations. A further burden imposed upon the IRS is the duty to negotiate withholding tax agreements with foreign financial institutions.

The effect of this new regime is unclear. However, the legislation permits a foreign financial institution to bypass the tax if they certify that it has no U.S. customers. This may prove tempting to many foreign institutions, on the grounds that doing business with U.S. customers might be too much of an administrative burden.

Reporting of Foreign Assets

The second major portion of FATCA is a new regime imposed upon U.S. taxpayers with specified financial assets in foreign jurisdictions. Current rules require applicable U.S. taxpayers to file an annual report, the "FBAR," with the Treasury's FinCEN (financial crimes center) by June 30 of the year following the year in which the filing threshold occurred (generally, $10,000 in total for all foreign bank account and financial accounts). FATCA imposes a new reporting regime, in part at odds with the FBAR regime, applicable only to individuals and certain trusts, and with a $50,000 aggregate threshold, rather than the $10,000 figure for FBARs. The FATCA regime also covers investments in foreign entities, such as foreign hedge funds; whereas recently issued FBAR regulations would exempt investments in foreign hedge funds. Unlike the FBAR, which is a Treasury form, any form implementing FATCA will be included in the taxpayer's federal income tax return for the year the information return covers.

A similar information return will apply to U.S. investors in Passive Foreign Investment Companies (such as foreign hedge funds and publicly offered foreign investment companies). This reporting is likely to overlap with the FATCA reporting, as well as FBAR reporting that would be required by recently issued proposed regulations. The Act also imposes similar information returns and penalties in respect of foreign situs trusts that have U.S. beneficiaries who are not reporting their interests in such trusts.

The Act imposes a 40% tax penalty on the underpayment of income tax by taxpayers who failed to report income from foreign financial accounts they did not disclose. The information return and tax penalty rules are effective for taxable years beginning after the date of enactment (March 18, 2010). (This appears to be in addition to the existing 50% penalty for not filing FBAR returns.) The Act also generally extends the statute of limitations for assessing taxes in cases where the taxpayer failed to report the income from foreign financial accounts, including a retroactive date for returns that have been filed but for which the statute of limitations for tax assessment has not expired.

Withholding Tax on Synthetic Dividend

Foreign recipients of U.S. dividends (an amount paid by a U.S. corporation to a shareholder out of certain after-tax profits), whether received directly or as a member of a partnership, are generally subject to a 30% U.S. withholding tax on the gross amount of the dividend. Where the foreign payee is entitled to the benefits of an income tax treaty, that rate is generally reduced to 15%. However, most foreign hedge funds are organized in a low-tax jurisdiction and must pay the full 30% tax. The tax is inapplicable in many transactions, including those where the foreign payee is a party to a notional principal contract ("swap") having periodic payments that are based on a notional dividend yield of U.S. equities.

The Act imposes U.S. withholding tax on any payment made under a swap that is determined, directly or indirectly by reference to a U.S. source dividend, and any payments made under a securities lending or similar transaction (a foreign shareholder authorizes a securities broker to transfer stock to a party that wants to sell the stock short). All of these types of transactions did not previously constitute an actual payment of dividends and were generally not subject to U.S. withholding taxes.

The definition of swap provides for a two-year transition period, during which only those swaps meeting specified criteria that are not generally employed, such as swaps where one party transfers to the other the underlying security (such as the basket of U.S. equities that the swap is based on). However, at the end of the period that is two years after the date of enactment (that is, March 18, 2012), all swaps will be covered unless the Treasury issues rules determining that this type of swap does not have the potential for tax avoidance.

The dividend withholding rules apply to payments on or after the date that is 180 days after the date of enactment (payments made on or after Tuesday, September 14, 2010 are covered).

The Health Care and Education Affordability Act of 2010 (the "Health Care Act")

This massive piece of legislation is to radically change our nation's healthcare system. Paying for this hugely expensive undertaking is a daunting task, to which Congress has responded with major tax legislation, incorporated in the Health Care Act.

"Medicare Tax"

The Health Act imposes a 3.8% income tax surcharge on taxpayers having certain thresholds of income, which is labeled a "Medicare Tax." Individuals are subject to an annual tax of 3.8% of the lesser of their net investment income or their modified adjusted gross income above a threshold amount ($250,000 for joint filers, $125,000 for married persons filing separately and $200,000 for all others). Carved out from net investment income are distributions from qualified retirement plans and certain business income. Trusts and estates are subject to a 3.8% tax on the amount of undistributed net investment income over the amount of taxable income at which the highest tax bracket for trusts and estates begins ($11,150 for tax year 2009).

The tax raised by the Health Care Act's provision may be allocated to the Supplementary Medical Insurance Trust Fund, which appears to be the reason for the label "Medicare Tax" although the 3.8% surcharge is clearly an income tax, not a Social Security tax. A taxpayer may be liable to the surcharge who has no earned income at all. The surcharge will be effective for taxable years beginning on or after January 1, 2013.

"Economic Substance Doctrine"

For tax-advantaged transactions, the Health Care Act requires a taxpayer to prove, if challenged, that a transaction has "economic substance" because the transaction: (1) changes the taxpayer's position in a "meaningful" way apart from the Federal income tax effects of the transaction; (2) is entered to a "substantial" purpose apart from its Federal income tax effects; and (3) has a potential for profit, after taking into account fees and other expenses and any applicable state, local and foreign taxes, that is "substantial" in relation to the net present value of the contemplated Federal income tax benefits. Very substantial penalties are provided where a taxpayer's underpayment of tax results from a transaction that runs afoul of this provision. This provision is effective for transactions after the date of enactment of the Health Care Act.

If you have any questions concerning this Tax Alert or any related matters, please contact Steven M. Etkind, 212-573-8412 (setkind@sglawyers.com) or Roger D. Lorence, 212-573-8413 (rlorence@sglawyers.com). We welcome your input.

In our Tax Alert of June 26, 2009, "The IRS Extends the Due Date for Some Filers of Foreign Bank Account and Financial Account Reports to September 23, 2009," we reported on informal guidance from several Internal Revenue Service ("IRS") lawyers on guidelines for filing Treasury Form TD F 90-22.1 (Report on Foreign Bank and Financial Accounts ("FBAR"). The IRS has reversed course on this issue and proposes to relieve many taxpayers from having to file the form with respect to foreign investment companies. However, this recent guidance may be overtaken by events in Congress.

Released on February 26, 2010, the Notice of Proposed Rulemaking (the "Notice") the Treasury's Financial Crimes Enforcement Network ("FinCEN") proposes to revamp the regulations governing the FBAR regime, and to issue revised instructions for completing the form. For Foreign Private Funds, we quote the applicable section of the Notice:

"FinCEN recognizes that outside of mutual funds and similar pooled funds, individuals may invest in other types of pooled investment companies, such as private equity funds, venture capital funds and hedge funds. Because these kinds of funds are privately offered funds, their characteristics vary greatly. In addition, the lack of functional regulation over these kinds of funds makes it difficult to define and distinguish certain types of these funds from others. FinCEN is aware, however, of pending legislative proposals that would apply additional regulation and oversight over the operations of some of these investment companies.
Accordingly, FinCEN has determined that, at this time, the proposal should reserve the treatment of investment companies other than mutual funds or similar pooled funds. Treasury remains concerned about the use of, for example, hedge funds to evade taxes and FinCEN will continue to study this issue."

Issuance of the Notice as final rules would resolve the uncertain issue of whether reporting of interests in foreign investment companies, whether public or private is required.

Further Developments
It is possible that the legislation pending in Congress regarding foreign financial assets of U.S. persons will be enacted, in which the legislation will govern the category of filers, foreign assets, timing, and other procedural matters. The content and deadlines for filing the FBAR remain unclear. The Notice is only a proposed amendment to the rules and does not explicitly reject the IRS lawyers' assertions that an interest in a foreign investment company is a covered "financial account." Therefore, we caution readers to monitor FBAR developments and to consult with your accountants as to the preparation of the forms.

If you have any questions concerning  any tax matters, please contact Steven M. Etkind, 212-573-8412 (setkind@sglawyers.com) or Roger D. Lorence, 212-573-8413 (rlorence@sglawyers.com). We welcome your input.

The Treasury Department has released its explanation of the President's February 2010 tax proposals. Many of these proposals, if enacted, would significantly impact the tax position of many readers. These proposals largely repeat the proposals issued in May 2009, which we described in http://www.hedgefundworld.com/documents/presidents-budget-proposals.pdf . The President proposes that the tax apply on July 1, 2010 and be subject to quarterly estimated corporate income tax filings. A brief narrative for each item follows.

Repeal of the Carried Interest
The manager of a partnership may receive an incentive allocation of partnership profits which is treated as a share of the various income components realized by the partnership that taxable year. This special allocation of profit is termed the "carried interest" and has been a major spur to development in the oil and gas, real estate, and fund industries. The President proposes to repeal the carried interest rules for taxable years beginning after December 31, 2010. This is the same effective date as in the 2009 proposals. The carried interest would be taxed as "services partnership interest" income that would be ordinary income, whatever the character of income generated by the partnership, and would be subject to self-employment taxes. Only a manager's profits on its own capital interest in the partnership would be exempt from these rules.

Higher Taxes From High Net-Worth Taxpayers
To fund deficit reduction, the President proposes numerous provisions aimed at the highest income taxpayers. Among them: higher tax rates (up to 39.6%), a 20% tax on long-term capital gains and qualifying dividends, and limitations on deductions. When combined with a proposed surcharge in the House version of the health care bill, upper-income taxpayers are looking at a 45% proposed rate, plus, of course, Social Security taxes and state and local income taxes, as applicable.

Attack on Dividend Swaps
Foreign taxpayers that receive dividends from U.S. corporations are subject to a 30% withholding tax on the gross amount of the dividend, unless the rate is reduced under an applicable income tax treaty. However, if a foreign taxpayer enters into a "dividend swap" whereby the foreign taxpayer receives swap payments based on the dividend yield of U.S. corporations, no U.S. withholding taxes are applied, based on longstanding Treasury regulations. The President proposes to reverse current law, for swap payments made after December 31, 2010, the same effective date as in 2009's proposals. There is a proposed exception for certain kinds of equity swaps that are speculative in nature, as opposed to a dividend-capture type of strategy. If enacted, the proposal may lead to double taxation of the same dividend; once in the hands of the domestic recipient (such as the swaps dealer entering into the contract with the foreign counterparty) and then to the foreign counterparty as well, as a "deemed" dividend.

Attack on Tax Shelters
The President would enact into law the so-called "economic substance" doctrine which has been applied by courts in inconsistent ways. A transaction would have economic substance only if it changes in a meaningful non-tax way, the taxpayer's economic position and the taxpayer has a substantial non-federal tax purpose for entering into the transaction. A 30% penalty would be applied to any tax deficiency attributable to a transaction lacking economic substance (reduced to 20% if the taxpayer disclosed the relevant facts on the return). The rule would apply to transactions entered into after the date of enactment.
International Tax Proposals
The President again takes aim at the regimes governing taxation of U.S. multinational corporations and U.S. taxpayers having bank accounts and financial accounts in other countries. U.S. corporate income taxes are presently among the highest among all industrialized nations, and it is not clear what impact the proposals, if enacted, would have on U.S. multinational corporations.

Life Insurance and Other Longevity Products

Life Settlements
Life Settlements are purchases of life insurance contracts from the insured by investors, who pay the remaining premiums due on the policy, and receive the death benefit (or cash surrender value of the policy). The President proposes to tighten up current rules regarding transfers of life insurance contracts in three instances. First, the purchaser of the contract whose death benefit is at least $500,000 (2009: $1 million) must report the purchase price, the buyer's and seller's tax identification numbers ("TINS"), the name of the issuer, and the policy number, to the Internal Revenue Service ("IRS"), the insurance company issuing the policy, and the seller. A new IRS Form 1099 is required.
Second, the insurance company making payments to a buyer of a life insurance contract must report to the IRS and the payee the gross benefit payment, the buyer's TIN, and the insurance company's estimate of the buyer's basis. A new IRS Form 1099 is required. It is unclear how the insurance company can estimate the buyer's basis, as this information is maintained on a confidential basis and is not provided to the life insurance company.
Third, the President would tighten up exemptions that provide where a policy is transferred for "fair value" the buyer must report gain on the policy to the extent amounts are received in excess of tax basis. The main exemptions relate to transfers where the transferee's basis is determined in whole or in part, by the transferor's basis. The mechanics by which the transfer-for-value rules would be tightened are not provided.
The 2010 proposals retain the January 1, 2011 effective date contained in the 2009 proposals. Because the forms, instructions, regulations and other guidance that would be required to complete the Form 1099 reporting for each transaction are not likely to be issued by that date, taxpayers will need to be very careful in collecting data. Every affected taxpayer will be required to make significant changes to their software and their business procedures in order to comply.

Separate Accounts
Investors may invest part of their life insurance premiums in a tax-deferred separate account at the life insurance company issuing the policy. The President proposes to require life insurance companies to report to the IRS detailed information about separate accounts, but only for those that are part of a group in which related persons own at least 10% of that separate account's value. The 2010 proposal would be effective for taxable years beginning after December 31, 2010, the same as in 2009 proposals.

Corporate Owned Life Insurance ("COLI")
Many corporations hold life insurance policies on the lives of key personnel, which include employees, officers, directors and 20% owners. Current law permits a corporation to deduct interest expense on loans taken out to fund premiums on such policies, subject to certain limitations. The President proposes to repeal the deduction for interest expense except for policies on the lives of persons owning at least 20% of the business, effective for life insurance contracts entered into after the date of enactment of the provision.

Annuities
Annuity contracts are usually issued by a life insurance company, whose customer transfers cash in exchange for the right to receive present, or future, payments for a term of years, or for life. Part of each payment is a return of capital and the rest is income to the annuity recipient. A proposal new to 2010 targets taxpayers that elect what is termed "partial annuitization," in which the holder of an annuity contract elects to use some of the account for a stream of periodic payments and the rest is kept in a tax-deferred account until it is used to support future payments. The President proposes to reform the rules for partial annuitizations entered into after December 31, 2010 so as to increase the portion of each payment that is taxable.

Commodities Dealers
Current law treats U.S. persons who are dealers in commodities, equity options, commodity derivatives as entitled to treatment under Section 1256 of the tax law whereby 60% of gain or loss is long-term capital gain and 40% is short-term capital gain (for so-called "60/40" contracts). The President proposes in a verbatim repeat of 2009's proposals, that dealer income of commodities dealers, including dealers in equity options and commodities derivatives, be taxable as ordinary income, effective for taxable years beginning after the date of enactment.

"Financial Crisis Responsibility Fee"
Despite the huge complexity such a tax and the enormous revenue it would raise, less than one and a half pages is devoted to this measure. The tax, which is intended to replace revenues lost on the bailout of the financial system, would be paid by banks, thrifts (such as savings and loans institutions), their holding companies, and securities broker-dealers. Institutions with under $50 billion of consolidated assets are exempt.
The tax will be "approximately" 0.0015 (15 basis points) times "covered liability amounts" ("CLA's"). CLA's are the worldwide consolidated liabilities of U.S. financial institutions and the liabilities of U.S. subsidiaries of foreign institutions, minus deposits as to which the Federal Deposit Insurance Corporation assesses fees, and for insurance companies, "certain" (unspecified) policy-related liabilities. The tax will be a "deterrent against excessive leverage for the largest financial firms" and encourage "less risky activities, such as lending against certain high quality collateral." Arguably, the tax would also deter lending to small businesses and other would-be borrowers that cannot produce "high quality collateral."

If you have any questions concerning any tax matters, please contact Steven M. Etkind, 212-573-8412 (setkind@sglawyers.com) or Roger D. Lorence, 212-573-8413 (rlorence@sglawyers.com

This is to advise you of changes in the federal tax laws that may have an effect on your current estate plan.

1. Is There a Federal Estate Tax in 2010?
A 2001 law reduced the bite of the Federal Estate Tax each year until 2010, when it ceases to apply - only to apply to estates of persons who die in 2011 and thereafter, at the same rates and exemptions from tax that applied on December 31, 2001. The 2010 repeal and the rollback to 2001 that is slated to take effect on January 1, 2011 were budgetary "gimmicks" which no one thought would ever come into being, but that is the state of things today. Bear in mind that the Federal Gift Tax was not repealed; in 2010 the tax applies at 35% on taxable gifts made over the taxpayer's lifetime to the extent the gifts are greater than $1,000,000 (lifetime total per taxpayer).
The tax basis of the decedent's assets that are held by the estate and its beneficiaries is also difficult to determine. The assets of the estate of a taxpayer who died on December 31, 2009 were increased, or decreased, to the value of each asset as of the date of death. This is known as "step up" basis, although, if assets have declined in value, it can equally be a "step down" basis. In 2010, because of the temporary repeal of the Federal Estate Tax, the assets' basis will, in general, be whatever the decedent's tax basis was in the asset immediately before death, with a number of modifications so that at least some assets will be stepped up or stepped down ("Carryover Basis").
Anyone who has ever been a fiduciary or adviser of an estate knows that determining what the decedent's basis in any particular asset can be difficult. For real estate, and for long-held illiquid assets of all kinds, this determination can at best be only an educated guess. In theory, educated guesses are allowed on tax returns, and a court may hold that where a taxpayer inherits assets and cannot prove what the tax basis is, the basis is zero.
One reading of the law is that the special Carry-over Basis rules above expire in 2011, and therefore we recommend that Executors for estates where the decedent died in 2010, wait until 2011 to sell significant assets, as the former rule of stepped up basis may resume in 2011 even for estates where the decedent died in 2010, even if the Federal Estate Tax is not retroactively repealed.

2. No Repeal for Residents of New York, Connecticut, and New Jersey
These states still impose a state level estate tax, as do many other states. Many states allow certain elections to be made if there is a corresponding election made on a federal estate tax return. If there is no Federal Estate Tax it is unclear how some of the state estate taxes will be imposed, and certain estates will pay more state estate taxes than previously contemplated when the estate planning was put in place.

3. Will the Federal Estate Tax Be Retroactively Reimposed in 2010?
Most estate planners and many in Congress believe that a law will be passed in 2010 retroactively imposing an estate tax for federal purposes in 2010. In fact, we think this is the consensus of those who practice in this area. As we get further into 2010, however, it becomes less likely that this "Retroactivity" will happen. There also is uncertainty in the law as to what happens to transfers made in 2010 prior to a retroactive estate tax law, and that uncertainty may take years to resolve in the courts.
We think that as many as 95% of those who we drafted Wills for in the past 8 years will not need to make changes in their Wills due to concerns about federal estate tax changes in 2010, but there may be certain state level estate taxes that may or may not be optimum in 2010 depending upon a client's particular situation. For years after 2010, assuming that the law is not changed, virtually all clients of this firm who we have drafted documents for in the past 11 years will not likely have to make changes to their documents. However, a review of their documents is warranted if their family situation or net worth has materially changed since their estate plan documents were executed.

4. Action Plan
Review of one's Wills and other estate planning documents should be made to see how these would apply under the 2010 law. Some people may be able to benefit from the one-year repeal, depending upon their personal circumstances. In some cases, a codicil or similar amendment, containing provisions that would apply only during the repeal of the Federal Estate Tax, could be implemented.
Another opportunity applies to the one-year repeal of the Federal Generation Skipping Tax ("GST"). This tax is most often paid by grandparents who have transferred wealth to grandchildren when those grandchildren's parents are still living. The tax is levied because of the "skipping" of a taxable transfer to the parents' generation. This tax, which is hated and widely misunderstood, can be defeated simply through making gifts to grandchildren, incurring the Gift Tax, which is lower than the skipping tax. How this would work with retroactive reimposition of GST in 2010 is not clear.

If you have any questions concerning any tax matters, please contact Steven M. Etkind, 212-573-8412 (setkind@sglawyers.com) or Roger D. Lorence,

 1.  Use Tax Losses Efficiently.  Planning for the effective use of tax losses is necessary, no matter how psychologically unpleasant.   Long-term or short-term capital loss carryovers from 2008 or an earlier year, or net operating losses (which are ordinary losses) from a business, are the most common tax losses.  Tax losses must be realized, meaning that market losses in a securities account are not tax losses until those securities are disposed of, or become worthless, there is a tax election treating unrealized positions as realized.  To analyze your 2009 taxes, you need to have the amounts of the categories of loss carry forwards from prior years, as well as an estimate of what any losses will be for 2009.  Capital losses of individuals are, generally, deductible only for the first $3,000 to the extent that capital losses are greater than capital gains in a year. 
If you are an investment manager and have taxable investors, bear in mind that if you have had a down year, you need to realize the tax losses your investors suffered economically, so that they can at least reduce their taxes.  We have seen some managers who have had a down year sell the winners and keep the losers, generating a tax liability for their investors.  
This is not the time to be sentimental about the losers.  Holding onto losers, or reacquiring the "same or substantially identical securities" within the 61 calendar day "wash sale period" (30 days prior to the sale at a loss, the date of the sale at a loss, and the next 30 days) is unwise.

2.  Selling Appreciated Securities.  You may own different lots of the same securities, each with its own holding period and tax cost, and may decide to sell only some of these lots.   You can usually direct the broker on which lots you want sold, even if all the lots are held in street name at the broker.  By doing so, you can ask for the highest cost securities to be sold, generating the least taxable profit, or, if you have tax losses you want to use up, sell the lowest cost lots.
 
3.  Gifts to Charities of Appreciated Securities.  Taxpayers who itemize their deductions can generally benefit by a contribution of appreciated securities to a charity recognized as such by the Internal Revenue Service.  The giver receives a tax deduction for the full fair market value of the securities, provided the giver has a long-term holding period (over one year) in each lot of the securities donated.  Giving securities whose value has depreciated is a bad idea, because you cannot deduct the loss, so it is better to sell the losing position and give the cash proceeds to charity. 
 
4.  Contributions to Retirement Plans.  To the extent that you can contribute to a retirement plan in 2009, or a later year, you should seriously consider doing so.  Every dollar of contribution saves tax dollars today and defers the day of (tax) reckoning until a date in the future. 
 
5.  Look at Roth Individual Retirement Plan (IRA) to See if Advantageous.   Here, we consider whether it may be preferable to wait until 2010 to take action.  Contributions to a Roth IRA are not tax-deductible, but distributions are generally not taxed either.  Taxpayers who have a regular taxable IRA and who want to convert it to a Roth IRA can do so, but only if their income is below certain income levels.  However, these income limits are waived for conversions in 2010.  This means that any taxpayer, who wants to, can convert to a Roth IRA in 2010, will owe income tax on the amount of the gain triggered by the conversion.  For taxpayers who have not used all of their 2009 losses and carry forwards, this can be an attractive option.
 
6.  Planning If You Are Not in the Alternative Minimum Tax ("AMT") for 2009.  The AMT (maximum 2009 rate of 28%) has various additions to the regular income tax rate.  You pay the higher if the regular rate is less than the AMT.  The tried-and-true strategies:  accelerate deductions in 2009, defer recognition of income, prepay state income taxes, prepay real property taxes, and make charitable contributions before year-end. 
 
7.  Planning If You Are in the AMT for 2009.  The maximum AMT rate is 28%, which is less than the maximum rate on ordinary income of 35%.  However, most tax deductions are not given effect in the AMT.  As a result, strategies such as accelerating deductions are not useful, as deductions are not taken into effect.