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PLANNING FOR THE 2013 TAX INCREASES Alan S. Gassman, Esq. Erica Good Pless, Esq. Companion Webinar for The. - ppt download
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Presentation on theme: "PLANNING FOR THE 2013 TAX INCREASES Alan S. Gassman, Esq. Erica Good Pless, Esq. Companion Webinar for The."— Presentation transcript:
PLANNING FOR THE 2013 TAX INCREASES Alan S. Gassman, Esq. Erica Good Pless, Esq. Companion Webinar for The Annihilation of Wealth 2013 October 18, 2012 2
2013 TAX RATES SUMMARY FROM BOOK ENTITLED THE ESSENTIAL PLANNING GUIDE TO THE 2013 INCOME AND ESTATE TAX INCREASES Copyright © 2012 Haddon Hall Publishing, LLP Medicare Tax2013 Highest Tax Long Term Capital Gain 15%20%3.8%23.8% Short Term Capital Gain 35%39.6%3.8%43.4% C Corporation Dividend Income 15%39.6%3.8%43.4% Ordinary Income35%39.6%3.8%43.4% Employment TaxesEmployer:1.45% Employee:1.45% Total:2.9% Employer:1.45% Employee:2.35% Total:3.8% (The additional.9% only applies as shown to the right.) Additional.9% on wages exceeding $200,000 for single taxpayers and $250,000 or married taxpayers. 3.8% total FICA/FUTA Taxes6.2% Employer/4.2% Employee on up to $110,100 of wages. 6.2% Employer 6.2% Employee on up to the wage base to be determined. 12.4% on wages up to the wage base. Estate Tax$5,120,000 Exemption 35% Rate $1,000,000 55% Rate N/A55% 2 3
Planning Tip #1 – Be prepared for the marriage penalty in 2013.Planning Tip #18 – Invest in tax exempt bonds. Planning Tip #2 – It may be best to trigger or receive income in 2012.Planning Tip #19 – Transfer appreciated assets to a Charitable Remainder Trust Planning Tip #3 – Marry someone who has large capital loss carry forwards. Planning Tip #20 – Convert passive real estate activities into active interests. Planning Tip #4 – Marry someone with large net operating losses (NOLs). Planning Tip #21 – Convert C corporations to S corporations. Planning Tip #5 – Invest in the following tax-advantaged vehicles.Planning Tip #22 – Materially participate in your S corporation or partnership to avoid the 3.8% Medicare tax. Planning Tip #6 – Maximize the use of the standard deduction.Planning Tip #23 – To avoid the 3.8% Medicare contribution tax on rental income, investors should consider converting triple net lease arrangements. Planning Tip #7 - Defer receiving Social Security benefits.Planning Tip #24 – Defer payments of medical expenses to 2013 to exceed the new 10% AGI limitations Planning Tip #8 – Taxpayers can reduce their wages below the applicable threshold. Planning Tip #25 – Make your parents or other elderly people who you help support dependents Planning Tip #9 – Companies that hire non-resident aliens as employees avoid paying U.S. FICA and Medicare taxes. Planning Tip #26 – Defer charitable contributions to 2013 to increase the tax benefit. Planning Tip #10 – To reduce self-employment taxes and liability exposure, self-employed taxpayers should consider forming a corporation or LLC. Planning Tip #27 – Purchase qualified property in 2012 up to the maximum Section 179 limit before the deduction limit is drastically reduced in Planning Tip #11 – Sell appreciated capital assets.Planning Tip #28 – It is possible to structure a partnership so that certain partners are taxed more than others. Planning Tip #12 – Contribute the maximum amount to retirement accounts. Planning Tip #29 – Elderly people with highly appreciated assets may be best advised to simply hold on to these assets Planning Tip #13 – Convert traditional IRAs to a Roth IRA.Planning Tip #30 – Pay most of the deductible expenses for an estate in the same year that the remaining estate assets are distributed. Planning Tip #14 – Contribute to deferred compensation plans.Planning Tip #31 – High earner taxpayers may consider placing capital gains- producing investments into simple trusts. Planning Tip #15 – Invest in qualified annuities.Planning Tip #32 - Maximize the election under Code 663(b) to treat distributions made in the first 65 days in 2013 as 2012 distributions. Planning Tip #16 – Invest in life insurance policies.Planning Tip #33 – Establish a Charitable Remainder Trust Planning Tip #17 – Invest in oil and working gas interests. Planning Tip # 34 – To avoid the 3.8% Medicare tax on oil and gas working interests convert limited partnership interests to general partnership interests. 34 Planning Tips 3 4
2013 Tax Increases - Introduction Beginning in 2013, taxpayers will see the highest level of tax rates in over two decades For example, individuals who derive their income from regular corporate dividends could be subject to a 63.21% effective rate of tax when taking into consideration the corporation's tax rate, the individual tax rate on dividends, and the 3.8% Medicare contribution tax! This is a 41.25% increase over the present effective rate of 44.75% that can apply to corporate income distributed to a shareholder 4 5
2013 Tax Increases - Introduction There are two major changes to the Medicare tax imposed by the Health Care and Education Affordability Reconciliation Act of 2010 ("Health Care Act"). One change is a 0.9% increase to the present 1.45% Medicare tax imposed on employees for wages and net self-employment income exceeding certain thresholds. The other, more expansive change is a 3.8% Medicare contribution tax on net investment income for high income taxpayers. Both of these changes take effect on January 1, 2013, and have some rather startling effects. 5 6
2013 Tax Increases - Introduction The income tax rates are scheduled to revert to pre-2001 levels, including the resurrection of the 39.6% tax bracket and the elimination of the 10% tax bracket. The combination of the 39.6% income tax rate along with the 3.8% Medicare contribution tax means that certain income will be taxed at the jaw-dropping rate of 43.4%! 6 7
2013 Tax Increases - Introduction Estate and gift tax rate currently at 35% will increase to 55% in 2013 Estate tax exclusion amount currently at $5,120,000 will be reduced to $1,000,000 in 8
2013 Tax Increases – Individuals A single person with taxable income of $1,000,000 will pay income taxes of $326,760 in 2012, compared to $365,517 in This is an increase of $38,757! This does not take into consideration the additional Medicare taxes or higher capital gain rates that will apply in 9
2013 Tax Increases – Individuals If taxable income is between: Tax imposedIf taxable income is between: (estimated*) Tax imposed $0 and $8,70010%N/A $8,700 and $35,350$ % of the excess over $8,700 $0 and $35,80015% $35,351 and $85,650$4, % of the excess over $35,350 $35,801 and $86,800$5, % of the excess over $35,800 $85,651 and $178,650$17, % of excess over $85,650 $86,801 and $181,050$19, % of the excess over $86,800 $178,651 and $388,350$43, % of the excess over $178,650 $181,051 and $393,650$48, % of the excess over $181,050 $388,351 and above$112, % of the excess over $388,350 $393,651 and above$125, % of the excess over $393,650 SINGLE TAXPAYERS *The income bracket thresholds for 2013 are based upon an estimated 1.37% inflation increase, which is the average of the increases over the past three years. The actual increase is scheduled for publication in September 10
2013 Tax Increases – Individuals If taxable income is between: Tax imposedIf taxable income is between: (estimated*) Tax imposed $0 and $17,40010%N/A $17,401 and $70,700$1, % of excess over $17,400 $0 and $71,65015% $70,701 and $142,700$9, % of excess over $70,700 $71,651 and $144,650$10, % of the excess over $71,650 $142,701 and $217,450$27, % of excess over $142,700 $144,651 and $220,400$31, % of the excess over $144,650 $217,451 and $388,350$48, % of excess over $217,450 $220,401 and $393,650$54, % of the excess over $220,400 $388,351 and above$105, % of excess over $388,350 $393,651 and above$117, % of the excess over $393,650 MARRIED TAXPAYERS *The income bracket thresholds for 2013 are based upon an estimated 1.37% inflation increase, which is the average of the increases over the past three years. The actual increase is scheduled for publication in September 11
2013 Tax Increases – Individuals Long-term capital gains are presently taxed at 15%, but will increase to 20% in Short-term capital gains are taxed at the highest income tax rate, which will increase from 35% to 39.6% in 2013, plus the 3.8% Medicare contribution tax, for a total rate of 43.4%. Qualified dividends have been taxed at long-term capital gains rates since Beginning in 2013, dividends will no longer receive preferential treatment and will be taxed at ordinary income rates; as high as 39.6% plus 3.8% Medicare tax, for a total rate of 43.4%. 11 12
2013 Tax Increases – Individuals Long-term capital gain tax rate 15%20% + 3.8% = 23.8% Short-term capital gain tax rate 35%39.6% + (3.8% on the lesser of: (1) net investment income or (2) the amount that MAGI exceeds $200k for single taxpayer and $250k for taxpayers filing a joint return) 12 13
2013 Tax Increases – Individuals It may be best to trigger or receive income in 2012 that would otherwise be received in 2013, if it will be taxed at a lower rate. In addition, it may be best to save expenses for 2013, since they will reduce income that will otherwise be taxed at a higher rate. This might include deferring large medical expense payments and the payment of property taxes, mortgage interest, charitable contributions, and other eligible itemized deductions. Sell long-term capital assets in 2012 to pay a 15% tax instead of a 20% or 23.8% tax (20% + 3.8% Medicare contribution tax if applicable). Consider electing out of installment sale treatment in 2012 to trigger lower capital gain rates in 2012 and avoid the 3.8% Medicare tax. Like-kind exchanges may become more popular in 14
2013 Tax Increases – Individuals Example Bob and Marry own a capital asset that they purchased 5 years ago. It has a basis of $1,000,000 and a fair market value of $11,250,00. If they sell this asset in 2012, they will pay capital gains tax of $1,537,500 (10,250,000 x 15% ). If they wait to sell this asset in 2013, they will pay capital gains tax of $2,050,000 (10,250,000 x 20%) Plus Medicare contribution tax: – Lesser of: 10,250,000 (MAGI) – 250k (threshold for MFJ TP) = 10,000,000 or Net investment income of 10,250, % x 10,000,000 = $380,000 The tax on the 2013 sale of the asset equals $2,430,000, an increase of $892,500 when 2013 is compared to 15
2013 Tax Increases – Individuals Deduction/CreditAGI Phase-outAvailable in 2012?Available in 2013? Expanded student loan interest deduction $75,000 for single filers $155,000 for married joint filers YESNO Expanded Adoption credit 2011 phase-out: $225, phase-out: $229,710 YESNO Child tax credit $75,000 for single filers $110,00 for married filers YESNO American Tax Credit $90,000 for single filers $180,000 for married joint filers YESNO Elimination of Itemized Deduction Limit $50,000 for single filers $100,000 for married joint filers (adjusted for inflation) YESNO State and local sales tax deduction $125,000 for single filers $250,000 for married joint filers NO Mortgage insurance premium deduction $54,500 for single filers $109,000 for married joint filers NO Tuition and fees deduction $80,000 for single filers $160,000 for married joint filers NO Deduction for IRA contribution up to $100,000 to charity N/ANO Teacher's supplies deduction N/ANO AMT Patch $33,750 for single filers $45,000 for married joint filers NO Mass Transportation benefit N/ANO Home energy credit N/ANO 15 16
2013 Tax Increases – Individuals The alternative minimum tax, better known by its acronym "AMT," imposes an alternate higher tax on certain taxpayers, including individuals, corporations, estates and trusts if their taxable income calculated with certain adjustments exceeds applicable thresholds. Congress enacted the tax in 1969 to prevent wealthy taxpayers from paying little or no tax by utilizing tax loopholes and taking large itemized deductions. For example, if John and Mary Smith had income of $350,000 and itemized deductions including $100,000 of mortgage interest paid on their principal residence (refinanced debt), $50,000 of property taxes, $50,000 of state income taxes, and $50,000 of foreign taxes, they would only have $100,000 of taxable income if not for the alternative minimum tax. When calculating taxable income for AMT purposes, they would not be able to deduct personal exemptions, miscellaneous itemized deductions, and state, local, and foreign taxes; as these are designated tax preference items that are not counted in determining a taxpayers alternative minimum tax. John's taxable income for AMT purposes would be $350,000 minus the applicable exemption. Assuming that the 2013 alternative minimum tax exclusion will be $45,000 and that the rate for AMT income not exceeding $175,000 will be 26% ($33,800) and the rate for income exceeding $175,000 will be 28% ($36,400) Johns alternative minimum tax will be $70,200. The AMT exemptions, found in Code § 55(d)(1), are not indexed for inflation. Each year Congress has stepped in and applied what has become known as the "AMT Patch" to increase the exemptions. For 2011, the exemption was increased to $48,450 for single taxpayers and $74,450 for married joint filers. For 2012, the exemption without a patch is $33,750 for single taxpayers and $45,000 for married joint filers. The exemptions phase out for taxpayers with income exceeding certain levels. For 2011, the exemption is zero for single taxpayers with income exceeding $306,300 and $447,800 for married joint filers. The AMT tax is the sum of 26% of the amount of AMT income that does not exceed $175,000 and 28% of the remaining excess. 16 17
2013 Tax Increases – Individuals Internal Revenue Code § 68 provides an overall limitation on itemized deductions for taxpayers whose AGI exceeds certain thresholds ($100,000 for married joint filers and $50,000 for single filers without adjustment for inflation). This limitation does not apply to medical expenses, investment interest, and casualty and theft losses. As originally enacted, the limit reduces itemized deductions by the lesser of: – 3% of the amount that AGI exceeds certain thresholds or – 80% of the amount of itemized deductions. In 2006 and 2007, the limit was reduced to 2%. For 2008 and 2009, the limit was reduced to 1%. For years 2010, 2011, and 2012, the limitation was eliminated. However, for 2013 the limitation will reappear at 3%. 17 18
2013 Tax Increases – Individuals For example, assume John and Mary's AGI in 2013 equals $500,000. Their itemized deductions equal $50,000. If the applicable threshold as adjusted for inflation for married joint filers is $175,000, their itemized deductions will be reduced by 9,750 as follows: Lesser of: – [3% x (500,000 – 175,000)] = 9,750 or – 80% x 50,000 = 40,000 – 50,000 – 9,750 = 40,250 The phase-out for personal exemptions for wealthy taxpayers will also return in Double whammy! 18 19
2013 Tax Increases – Individuals 0.9% Medicare tax – Internal Revenue Code Sections 1301 and 1401 were amended by The Health Care Act and impose an additional 0.9% Medicare tax on wages and net self- employment income of individuals exceeding $250,000 for married taxpayers filing a joint return, $125,000 for married taxpayers filing a separate return and $200,000 for all other taxpayers. – Taxpayers cannot take an income tax deduction for the additional tax on self-employment income. 19 20
2013 Tax Increases – Individuals Example Sally is single and earns a salary of $225,000. Her employer offers a 401(k) plan where she can contribute up to 15% of her salary. She contributes the full 15% to the 401(k) plan because this will reduce her MAGI below the $200,000 threshold and she will not be subject to 0.9% Medicare tax in $225,000 x 15% = $33,750 (contribution to 401(k)) $225,000 - $33,750 = $191,250 (taxable salary below threshold) For 2013, this saves an estimated $12,150 in income taxes and $225 in Medicare taxes. 20 21
2013 Tax Increases – Individuals 3.8% Medicare contribution tax – Applies to single taxpayers whose Modified Adjusted Gross Income exceeds $200,000 a year, $125,000 for taxpayers filing separately or $250,000 for a married couple filing jointly. – The tax is imposed on net investment income, and only to the extent that total Modified Adjusted Gross Income exceeds the above thresholds. 21 22
2013 Tax Increases – Individuals Technically, the tax is imposed on the lesser of: – Net investment income; or – The amount by which Modified Adjusted Gross Income ("MAGI") exceeds $200,000 for single taxpayers, $250,000 for taxpayers filing joint returns, and $125,000 for all other taxpayers. 22 23
2013 Tax Increases – Individuals For example, a married couple filing a joint return with MAGI of $500,000, including net investment income of $100,000 will pay the 3.8% Medicare contribution tax on the lesser of: – Net investment income of $100,000 or – MAGI of $500,000 – MFJ threshold of $250,000 = $250,000. The lesser of $100,000 or $250,000 is $100,000. Therefore, the 3.8% is imposed on $100,000, or $3, 24
2013 Tax Increases – Individuals For purposes of the 3.8% Medicare tax, net investment income includes interest, dividends, royalties, income from annuities, and net rental income (gross rents minus allowable expenses) that have not been derived in the ordinary course of trade or business. It also includes the net gain from the disposition of property other than property held in the course of a trade or business (capital gains). The tax also applies to trades and businesses that generate passive activity income and a trade or business that trades in financial instruments or commodities. Net investment income does not include income received from distributions from active interests in S corporations or partnerships, qualified retirement plans, deferred compensation plans, qualified annuity plans, or tax exempt bonds. Wages and social security income are exempt. The 3.8% tax also does not apply to nonresident aliens or to charitable trusts income. 24 25
2013 Tax Increases – Individuals Type of IncomeSubject to 3.8% tax? YESNO Interest and DividendsX Net Capital GainsX Royalties and net rental incomeX Installment sales proceedsX Gain from the sale of personal residence in excess of the IRC § 121 exclusion X Passive income from S corporationsX Passive activity incomeX Income from a trade or business that trades in financial instruments or commodities (hedge fund) X Active income from S corporationsX WagesX Income from qualified pension, profit- sharing plan and stock bonus plans X Social Security IncomeX Tax Exempt InterestX 25 26
2013 Tax Increases – Individuals How to Avoid or Minimize the 3.8% Medicare tax 1.Sell appreciated capital assets in 2012 and invest the gains in vehicles that are not subject to the 3.8% tax; 2.Contribute the maximum amount to retirement accounts; 3.Convert traditional IRA to a ROTH IRA (with caution); 4. Contribute to Deferred Compensation Plans; 5. Invest in qualified annuities, assuming that the cost of acquisition and maintenance does not exceed the tax savings; 6. Invest in life insurance policies, assuming that the cost of acquisition and maintenance does not exceed the tax savings; 7. Invest in oil and working gas interests; 8. Invest in tax exempt bonds; 9. Transfer appreciated assets to a Charitable Remainder Trust (CRT); 10. Convert passive real estate activities to active interests; 11. Convert C corporations to S corporations (with caution). 26 27
2013 Tax Increases – Individuals SELL APPRECIATED CAPITAL ASSETS IN 2012 Bill purchased stock in Tech Company for $100,000 more than a year ago that is presently worth $600,000. Bill is thinking about selling the stock because he is concerned that its value may decrease due to Tech Company's competitors. If Bill sells the stock in 2012 he will pay a 15% capital gains tax rate, which amounts to $75,000. If Bill waits to sell the stock in 2013, he will pay a capital gains tax rate of 20%, which amounts to $100,000 [($600,000 - $100,000) x 20%]. Additionally, capital gain income is considered net investment income for purposes of the 3.8% Medicare contribution tax. Therefore, if Bill is single and has no other income he will pay 3.8% tax on the lesser of: – 1) $500,000- $200,000 = $300,000 (the difference between MAGI and the threshold for single filers); or – 2) $500,000, (net investment income). Bill will pay $11,400 in Medicare contribution taxes ($300,000 x 3.8% = $11,400). Therefore, if Bill waits to sell the stock in 2013 he will pay $111,400 in taxes on the capital gain, a difference of $36,400! 27 28
2013 Tax Increases – Individuals CONTRIBUTE THE MAXIMUM AMOUNT TO INDIVIDUAL RETIREMENT ACCOUNTS TO REDUCE MAGI Brad and Angela finally get married. In 2013, they both earn salaries of $125,000 and receive interest and dividends of $10,000, for a total MAGI of $260,000. They will pay 3.8% Medicare contribution tax on the lesser of: – $260,000 (MAGI) - $250,000 (Threshold for married joint filers) = $10,000; or – $10,000 (net investment income) They will pay additional Medicare contribution taxes of 3.8% x $10,000 = $380. If they each contribute $5,000 to a traditional IRA account in 2013 (the current maximum for taxpayers under 49), they will avoid both Medicare contribution taxes since this reduces their MAGI to $250,000 (assuming they are not covered by a retirement plan at work). – $250,000 (wages) - $10,000 (IRA contributions) = $240,000 – $240, ,000 (investment income) = $250,000 (MAGI) If they are over age 49, they would be able to each contribute $6,000 to a traditional IRA. 28 29
2013 Tax Increases – Individuals CONSIDER CONVERTING TRADITIONAL IRA TO ROTH IRA In 2013, if Brad and Angela retire and receive only $200,000 in interest and dividends but are required to take minimum distributions from their traditional IRAs totaling $100,000, their MAGI will be $300,000. Therefore, they will be subject to the 3.8% tax on $50,000 (the difference between MAGI and the threshold for married filers). While traditional IRA distributions are not considered investment income for purposes of the 3.8% tax, they are included in the MAGI calculation. If Brad and Angela are eligible to convert their traditional IRAs to ROTH IRAs in 2012, the distributions from the ROTH IRAs in 2013 will not be included in the calculation for MAGI purposes and will not be considered investment income. In the above example, if the $100,000 distributions came from ROTH IRA accounts, Brad and Angela's MAGI would only be $200,000, which is below the $250,000 threshold for the 3.8% tax. Note, however, that there are other tax consequences that apply when a traditional IRA is converted to a ROTH IRA. When this occurs, the taxpayer pays income tax on the monies that come out, which will be as high as 35% for high income taxpayers in Since this is expected to go up to 39.6% in 2013, ROTH IRA conversions should be completed before the end of The decision to convert to a ROTH account should be made after a complete tax analysis and consultation with a qualified tax attorney or certified public accountant. If you decide to convert you should do so in 2012, as the conversion amount will be included in the MAGI calculation for purposes of the 3.8% tax. 29 30
2013 Tax Increases – Individuals CONTRIBUTE TO DEFERRED COMPENSATION PLANS OR QUALIFIED ANNUITY PLANS Cameron and her husband, Justin are teachers. They both earn salaries of $50,000. In addition to their salaries, they receive $184,000 in royalties for a total MAGI of $284,000. Cameron's smart tax attorney advises them to contribute the maximum amount to their 403(b) and 401(k) accounts ($17,000 each for 2012) to avoid paying 3.8% Medicare contribution tax in – 284,000 – 34,000 = 250,000 This will save them an estimated $12,240 in income taxes and $1,292 in Medicare contribution taxes in 31
2013 Tax Increases – Individuals PURCHASE LIFE INSURANCE POLICIES Life insurance is not only a great estate planning vehicle (if structured properly). It can also be used to mitigate the 3.8% Medicare contribution tax. The income that builds up inside the whole life insurance policy that exceeds the amount of premiums paid is not subject to tax, and death proceeds or loans that are exempt from income tax are not subject to the Medicare contribution tax. However, life insurance policies can be expensive and complicated rules apply with respect to what can be done from a structuring and loan standpoint. 31 32
2013 Tax Increases – Individuals INVEST IN AN OIL AND WORKING GAS INTEREST Individual taxpayers who directly own oil and working gas interests or whose liability is not limited by holding a limited partnership, corporation or limited liability company interest in an oil and working gas investment are not subject to the 3.8% Medicare contribution tax. 32 33
2013 Tax Increases – Individuals INVEST IN TAX EXEMPT BONDS Interest received from tax-exempt bonds such as municipal bonds are not subject to income tax and also escape the 3.8% Medicare contribution tax. Taxpayers should evaluate their investment portfolios and consider tax-exempt bonds as an alternative to investments that generate taxable interest and dividends. Warren, a single man, has an investment portfolio that generates taxable dividend and interest income of $1,000,000 per year. Without planning, in 2013, Warren will be subject to the highest rate of income tax at 39.6% plus 3.8% Medicare contribution tax on the net investment income that exceeds $200,000. $1,000,000 x 39.6% = $396,000 (income tax ignoring deductions and exemptions) $1,000,000 - $200,000 (threshold for single taxpayer) = $800,000 (subject to 3.8% Medicare contribution tax) $800,000 x 3.8% = $30,400 (Medicare contribution taxes) Total 2013 taxes without planning: $426,400 If Warren sells or transfers assets in 2012, and invests in tax-exempt bonds so that he receives $800,000 in tax-exempt interest, he will avoid the 3.8% Medicare contribution tax and will only be subject to income tax on $200,000 in 34
2013 Tax Increases – Individuals CAUTION: President Obama has proposed that taxpayers with income exceeding certain thresholds ($200,000 for single filers and $250,000 for joint filers) may not exclude all municipal bond interest from taxable income. President Obama has also proposed the "Buffet Rule" which would require taxpayers with annual incomes exceeding $1 million to pay income taxes at a 30% tax rate. 34 35
2013 Tax Increases – Individuals TRANSFER APPRECIATED ASSETS TO A CHARITABLE REMAINDER TRUST (CRT) To avoid paying capital gains tax and the 3.8% Medicare contribution tax, a taxpayer could transfer a highly appreciated asset to a charitable remainder trust (CRT). The taxpayer would receive an income or annuity interest for life or a period of years. Upon the death of the taxpayer or the expiration of the designated time period, the remainder interest would be transferred to a charitable entity of the taxpayer's choice. Additionally, the taxpayer would receive an income tax deduction equal to the present value of the remainder interest. 35 36
2013 Tax Increases – Individuals CONVERT PASSIVE REAL ESTATE ACTIVITIES TO ACTIVE INTERESTS Net rental income is subject to the 3.8% Medicare contribution tax unless the taxpayer materially participates in the real estate business. If possible, in 2013, taxpayers should actively manage rental real estate properties and limit triple net leases. 36 37
2013 Tax Increases – Individuals CONVERT C CORPORATIONS TO S CORPORATIONS S corporations will become even more popular in 2013, due to the increased tax on dividends from C corporations. Currently, dividends are taxed at 15% but in 2013, they will be subject to the highest ordinary income tax rate of 39.6%. Additionally, taxpayers with MAGI exceeding certain thresholds may be subject to the 3.8% Medicare contribution tax as well. 37 38
2013 Tax Increases – Corporations Taxable IncomeIncome TaxesEffective tax rate $335,000$113,90034% $10,000,000$3,400,00034% $15,000,000$5,150, % $18,333,333$6,416,66735% Effective Tax Rates for C Corporation 38 39
2013 Tax Increases – Corporations Under current law, non-corporate shareholders who receive dividends from C corporations are taxed at a preferential rate of only 15%. C corporations that receive dividends from another C corporation also receive preferential tax treatment under the dividends received deduction. Prior to 2003, shareholders who received dividends from C corporations were taxed at ordinary income rates after the income had previously been taxed at the corporate level. Congress recognized that this double tax regime was unfair and was slowing economic growth, and responded by lowering the tax rate on dividends. However, if Congress does not extend the 15% preferential rate, dividends will once again be taxed at ordinary income rates. Additionally, the dividends are considered investment income under Code § 1411(c)(1)(A)(i) and are subject to the 3.8% Medicare contribution tax. The higher dividend tax rate will encourage C corporations to reinvest money, and discourage distributions and consumption by the shareholders. 39 40
2013 Tax Increases – Corporations Assuming the rates remain the same for corporations in 2013, a personal services C corporation having $500,000 of net income will pay $175,000 in income taxes ($500,000 x 35%). If the net of $325,000 is paid as a dividend to an individual who is in the highest tax bracket and whose MAGI exceeds the applicable threshold by the amount of the dividends, the dividends will be subject to the 3.8% Medicare contribution tax plus the 39.6% income tax rate. – $500,000 x 35% = $175,000 (Corporate income tax) – $500,000 - $175,000 = $325,000 (Dividend paid to shareholder) – $325,000 x 43.4% = $141,050 (Individual income tax) – $325,000 - $141,050 = $183,950 (Net to shareholder after taxes) – $175,000 + $141,050 = $316,050 (Total taxes paid) The total corporate and individual income taxes paid on the corporate earnings totals $316,050, which is a 63% total tax on $500,000 corporate income. In other words, the shareholder only receives cents for each one dollar earned by the corporation. 40 41
2013 Tax Increases – Corporations The following illustrations show the combined tax bracket of 63.21% where a C corporation has taxable income exceeding $100,000 and distributes it to a shareholder who will be in the 39.6% bracket and has to pay the 3.8% Medicare contribution tax on these dividends. This is a significant increase considering the 44.75% overall bracket that currently applies. That comes to $18,460 more in taxes with an effective rate of 63.21%. The effective tax rate will increase by 41.2% for successful C corporation owners in [( ) /44.75] 2013 Calculations: – $100,000 x 35% = $35,000 corporate tax – $100,000 - $35,000 = $65,000 net after corporate tax – $65,000 is distributed to Shareholder as a dividend – $65,000 x 43.4% = $28,210 individual income tax – $65,000 - $28,210 = $36,790 net to shareholder – $35,000 + $28,210 = $63,210 total taxes paid on $100,000 41 42
2013 Tax Increases – Corporations 2012 Calculations – $100,000 x 35% = $35,000 corporate tax – $100,000 - $35,000 = $65,000 net after corporate tax – $65,000 is distributed to Shareholder as a dividend – $65,000 x 15% = $9,750 individual income tax – $65,000 - $9,750 = $55,250 net to shareholder – $35,000 + $9,750 = $44,750 total taxes paid on $100,000 The above calculations demonstrate that in 2013, C corporations may want to increase salary payments to their shareholder/employees instead of paying out higher dividends. However, keep in mind that wages exceeding certain thresholds are subject to an additional 0.9% Medicare tax and the highest ordinary income tax bracket will be 39.6% in 43
2013 Tax Increases – Corporations EXAMPLE: John Smith is a shareholder of an IT corporation structured as a C corporation. In 2012, he earns a salary of $300,000 and receives a dividend of $500,000. He files a joint return with his wife who earns no income. Assume the $300,000 is fully taxable salary and their MAGI is $800,000. The $500,000 dividend will be treated as a qualified dividend and taxed at the preferential rate of 15%. ($500,000 x 15% = $75,000) In 2013, barring no changes to the taxable wage base John will pay an additional.9% on his wages that exceed $250,000 ($450) and an additional 3.8% on the $500,000 dividend ($19,000) for a total of $31,077 in FICA taxes on the same amount of income! In addition, if the preferential tax rate on dividends is eliminated for 2013 and the pre-Bush tax rates are restored, John will pay income tax on the dividend at the highest ordinary income tax rate of 39.6%. 43 44
2013 Tax Increases – Corporations In 2013, S corporations will continue to escape taxation, subject to a few exceptions. S corporation shareholders will avoid the 3.8% Medicare contribution tax, with the exception of distributions attributable to net investment income. Therefore, an S corporation shareholder in the highest income tax bracket will pay a tax rate of 39.6% on salary plus an additional 0.9% Medicare contribution tax, in the same way that a C corporation shareholder would. 44 45
2013 Tax Increases – Corporations Consider converting C corporations to S corporations but beware of the two tax traps: 1.Built-in Gains Tax. Once a C Corporation has assets that have increased in value, it cannot simply avoid the tax on the potential capital gain by making an S election. That gain is called built-in gain and is tagged in the year the S election is made. If an asset with built-in gain on the date the S election is later made is sold within 10 years of the date of the S election, then a corporate level capital gains tax is imposed. The tax is computed at the highest rate applicable to C corporations, currently 35%. Congress reduced the 10 year period to 5 years through sales occurring before January 1, 2012, but it has reverted back to 10 years for 2012 and thereafter. 2. The Sting Tax. When a C corporation converts to an S corporation and produces passive income exceeding 25% of gross receipts, a sting tax is imposed. Oftentimes the corporation can avoid this tax by purchasing a business with high gross receipts, such as a gas station. Also, if the S corporation does not take corrective measures to either reduce its earnings and profits or the passive income, its status as an S corporation may be jeopardized. If the company has sting tax earnings for three consecutive taxable years, the S corporation status will be lost. 45 46
2013 Tax Increases – Corporations To the extent that the S corporation has net income attributable to passive activities, shareholders with MAGI that exceed the applicable thresholds will pay the 3.8% Medicare contribution tax. The term passive activities comes from a complicated set of rules that enacted in 1986 called the passive loss rules. These rules prevent many taxpayers from taking tax losses where they have rental income or similar businesses where the depreciation deductions and interest deductions associated with the business exceed the rental income. Generally, a passive activity is defined as any trade or business where the taxpayer does not materially participate. Materially participate in your S corporation or partnership to avoid paying the 3.8% Medicare contribution tax. To avoid the 3.8% Medicare contribution tax on rental income, investors should consider converting triple net lease arrangements to active leases and become actively involved in the real estate business in order to qualify as real estate professionals under Code § 469(c)(7). 46 47
2013 Tax Increases – Corporations EXAMPLE: John Smith is a doctor and structures his medical practice as an S corporation. John earns a salary of $300,000 and receives $500,000 in K-1 income from the S corporation. He is married but his wife does not earn any income. The additional 3.8% Medicare contribution tax will not be imposed on John's K-1 income in 2013 unless John is a passive investor or the S corporation's profits are comprised of interest, dividends, capital gains, or rental income. John will still be subject to the additional 0.9% Medicare tax on the excess wages (300,000 – 250,000 = 50,000 x.9% = 450). Compare to the previous example where John paid $19,000 in Medicare taxes on the K-1 income from the C corporation. 47 48
2013 Tax Increases – Corporations Assume the same facts as above except the S corporation's business profits include $100,000 of rental income from a passive arms length tenant. In 2013, the additional 3.8% Medicare contribution tax will be imposed on the $100,000 portion of the K-1 income, regardless of whether John is an active participant in the corporation. (100,000 x 3.8% = $3,800) John will also be subject to the.9% additional tax on his wages that exceed the threshold for MFJ taxpayers. (300,000 – 250,000 = 50,000 x.9% = $450) 48 49
2013 Tax Increases – Corporations S CORPORATION OWNS AND MANAGES RENTAL REAL ESTATE SHAREHOLDER A (qualifies as real estate professional) SHAREHOLDER B (passive investor) $200,000 K-1 INCOME 49 50
2013 Tax Increases – Corporations Shareholder A's K-1 income from the S corp will not be subject to the additional 3.8% Medicare contribution tax if he qualifies as an active investor. A taxpayer who qualifies as a real estate professional pursuant to IRC § 469(c)(7) will be considered an active investor. This rule requires that the taxpayer spend at least 750 hours each year materially participating in the activity and spend more than 50% of his or her personal services time materially participating in the real property trade or business. As wages in excess of the applicable thresholds will still be subject to the.9% additional Medicare contribution tax. For example, in 2013 if A is single and he receives wages of $300,000 he will pay an additional $900 in Medicare contribution taxes calculated as follows: – 300,000 (wages) – 200,000 (threshold for single TP) x.9% = $900 However, unlike B, he will not be required to pay Medicare contribution taxes on the $200,000 K-1 income. 50 51
2013 Tax Increases – Corporations Shareholder B's K-1 income from the S corp will be subject to the additional 3.8% Medicare contribution tax because he does not qualify as a real estate professional. Assume Shareholder B is single and that in 2013 he receives K-1 income from this S corp totaling $200,000. Further assume that he earns wages totaling $300,000 and that his MAGI is $500,000. The additional Medicare contribution taxes are calculated as follows: 0.9% Medicare tax – 300,000 (wages) – 200,000 (threshold for single TP) x.9% = $ % Medicare contribution tax Lesser of: – 500,000 (MAGI) – 200,000 (threshold for single TP) = 300,000 or – Net investment income of 200,000 – 3.8% x 200,000 = $7,600 B will pay $8,500 in new Medicare taxes in 52
2013 Tax Increases – Corporations 179 deduction limitLimit on purchasesBonus Depreciation 2009$250,000$800,00050% 2010$500,000$2,000,000 50% for property placed in service before 9/8/10 and 100% for property placed in service after 9/8/ $500,000$2,000,000100% 2012$139,000$560,000 50% for most property 100% for certain property with useful life of 10 years or more and transportation property 2013$25,000$200,0000% for most property 50% for certain property with useful life of 10 years or more and transportation property 52 53
2013 Tax Increases – Corporations Take advantage of the Section 179 and 50% bonus depreciation before year end! Example – In 2012, Tom purchases an asset for his business that costs $500,000. He can take a Section 179 deduction of $139,000 and 50% bonus depreciation of $180,500. Assuming the asset has a 5 year life, he can also take normal first year depreciation of $36,100. Assuming a 35% tax rate, this will result in savings of $124,460. If Tom waits to purchase this asset in 2013, he will be limited to normal first year depreciation with no Section 179 deduction or bonus depreciation. The Section 179 deduction will not be available to Tom because the dollar limit on purchases for 2013 is only $200, 54
2013 Tax Increases – Trusts and Estates Taxable incomeTax $0-$2,40015% $2,401-$5,600$360 plus 25% of the excess over $2,400 $5,601- $8,500$1,160 plus 28% of the excess over $5,600 $8,501-$11,650$1,972 plus 33% of the excess over $8,500 $11,651 +$3, plus 35% of the excess over $11, Current income tax rates for trusts 55
2013 Tax Increases – Trusts and Estates For example, if a non-grantor trust has $100,000 of income and distributes all of it to the beneficiaries, then the trust pays zero tax. However, if the trust does not distribute the $100,000 and has no other deductions, the trust will be subject to a tax of $33, 56
2013 Tax Increases – Trusts and Estates In addition to income taxes, in 2013 trusts and estates will also be subject to the 3.8% Medicare contribution tax. The tax is imposed on the lesser of: – The undistributed net investment income of a trust or estate or – The amount by which the AGI exceeds the top-inflation adjusted bracket for estate and trust income (expected to be approximately $12,000 in 2013) If a trust has $300,000 in undistributed net investment income it will pay 3.8% Medicare contribution tax on (300,000 – 12,000 = 288,000), or $10,944. Conversely, if the trust distributes $100,000 pro rata to each of its two beneficiaries and retains $100,000, then it will pay tax on the $100,000 retained, and the beneficiaries will pay tax based upon $100,000 each. The trust will pay the Medicare contribution tax on the excess of the $100,000 it retained over the $12,000 exemption ($88,000 x 3.8% = $3,344). 56 57
2013 Tax Increases – Trusts and Estates 57 TRUST $300,000 undistributed net investment income BENEFICIARY A (Single TP, MAGI = $150k) BENEFICIARY B (Married TP, MAGI = $500k) 58
2013 Tax Increases – Trusts and Estates If Beneficiary A has other income exceeding $100,000 then he will be subject to the 3.8% Medicare contribution tax on the lesser of the distribution or the amount exceeding $200,000 (the applicable threshold for single taxpayer). If Beneficiary B is married and files a joint return and has $200,000 of other Adjusted Gross Income, then Beneficiary B and spouse will pay the Medicare contribution tax on $50,000. (3.8% x $50,000 = $1,900) If Beneficiary A does not have other income, he will not be subject to the additional Medicare contribution tax because his MAGI does not exceed $200,000, the threshold for a single taxpayer. However, Beneficiary B will be subject to the 3.8% Medicare contribution tax on the distribution calculated as follows: Lesser of: – 500,000 (MAGI) – 250,000 (threshold for MFJ) = 250,000 or – Net investment income of 150, % x 150,000 = $5,700 58 59
2013 Tax Increases – Trusts and Estates In 2013, trustees will need to evaluate the tax consequences of accumulating or distributing income to avoid the 3.8% Medicare contribution tax. If the trustee does not distribute any of the trust income, the trust will be subject to the 3.8% Medicare contribution tax, totaling $10,944. – 300,000 – 12,000 = 288,000 – 288,000 x 3.8 = 10,944 If the trustee distributes the income pro rata, Beneficiary A will not be subject to the additional Medicare contribution tax because his MAGI does not exceed $200,000, the threshold for a single taxpayer. However, Beneficiary B will be subject to the 3.8% Medicare contribution tax on the distribution calculated as follows: – Lesser of: 500,000 (MAGI) – 250,000 (threshold for MFJ) = 250,000 or Net investment income of 150,000 – 3.8% x 150,000 = $5,700 59 60
2013 Tax Increases – Trusts and Estates Consider selling appreciated assets to a charitable remainder trust (CRT) John is a 60 year old, single, wealthy man who transfers assets with a fair market value of $2,000,000 and a basis of $500,000 to a charitable remainder annuity trust. By transferring these assets to the CRAT, John avoids paying a capital gains tax of $349,400 in – $2,000,000 - $500,000 = $1,500,000 (capital gain) – $1,500,000 x 20% (long-term capital gain) = $300,000 Medicare contribution tax calculation – Lesser of: $1,500,000 - $200,000 (threshold for single filer) = $1,300,000 $1,500,000 – $1,300,000 x 3.8% = $49,400 – $300,000 + $49,400 = $349,400 John also benefits by receiving an income tax charitable deduction on the present value of the charitable remainder interest. John may be able to carryforward any unused portion of the charitable deduction to offset taxable income in future years. Assuming a Section 7520 discount rate of 1.4%, John receives an annuity interest from the trust of $100,000 per year for 20 years. If John's annual income does not exceed the 3.8% threshold of $200,000, he will not be subject to the 3.8% Medicare contribution tax. See Chapter 4, number 9 for more details on this example. 60 61
2013 Tax Increases – Trusts and Estates A taxpayer creating a CRT will obtain numerous income tax advantages. The taxpayer will receive a charitable deduction when the CRT is funded. The deduction is equal to the value of the charitys remainder interest in the trust. The taxpayer is allowed the deduction in the year the trust is created, even though the charity will not receive the property until a later date. Trusts that qualify as CRTs will not be subject to the 3.8% Medicare Contribution Tax. Also, in many states, the annuity interest received by the Grantor should be protected from the creditors of the Grantor. In addition, the CRTs generally do not pay income taxes. Therefore, a taxpayer could contribute a highly appreciated asset to the CRT. The CRT could then sell the asset and should not have to recognize any gain on the sale. This allows the additional value that would otherwise have to be used to pay income taxes to be reinvested in the trust, possibly increasing the payments back to the grantor depending on the terms of the trust. This should also result in the charity receiving more assets at the end of the CRT, although this will not have any impact on the charitable deduction allowed to the taxpayer. Because the rules related to CRTs, both with respect to their formation and operation, are very complex, a taxpayer interested in possibly establishing a CRT is strongly encouraged to consult with a qualified tax professional. 61 62
Conclusion The January 1, 2013 deadline is fast approaching, and brings with it the possibility that the gift tax exemption and the estate tax exemption will be reduced to only $1,000,00. These potential dramatically reduced exemption amounts coupled with presently low valuations and the ability to use discount planning in conjunction with gifting makes it very clear that affluent families will benefit greatly from establishing and funding a SAFE trust before the end of While the authors have provided the foregoing basic information to assist you in your estate an gift tax planning for 2012 a good deal of thought and preparation may be necessary depending upon the circumstances of the family and their planning, so start sooner rather than later! 62 63
Planning Tip #1 – Be prepared for the marriage penalty in 2013.Planning Tip #18 – Invest in tax exempt bonds. Planning Tip #2 – It may be best to trigger or receive income in 2012.Planning Tip #19 – Transfer appreciated assets to a Charitable Remainder Trust Planning Tip #3 – Marry someone who has large capital loss carry forwards. Planning Tip #20 – Convert passive real estate activities into active interests. Planning Tip #4 – Marry someone with large net operating losses (NOLs). Planning Tip #21 – Convert C corporations to S corporations. Planning Tip #5 – Invest in the following tax-advantaged vehicles.Planning Tip #22 – Materially participate in your S corporation or partnership to avoid the 3.8% Medicare tax. Planning Tip #6 – Maximize the use of the standard deduction.Planning Tip #23 – To avoid the 3.8% Medicare contribution tax on rental income, investors should consider converting triple net lease arrangements. Planning Tip #7 - Defer receiving Social Security benefits.Planning Tip #24 – Defer payments of medical expenses to 2013 to exceed the new 10% AGI limitations Planning Tip #8 – Taxpayers can reduce their wages below the applicable threshold. Planning Tip #25 – Make your parents or other elderly people who you help support dependents Planning Tip #9 – Companies that hire non-resident aliens as employees avoid paying U.S. FICA and Medicare taxes. Planning Tip #26 – Defer charitable contributions to 2013 to increase the tax benefit. Planning Tip #10 – To reduce self-employment taxes and liability exposure, self-employed taxpayers should consider forming a corporation or LLC. Planning Tip #27 – Purchase qualified property in 2012 up to the maximum Section 179 limit before the deduction limit is drastically reduced in Planning Tip #11 – Sell appreciated capital assets.Planning Tip #28 – It is possible to structure a partnership so that certain partners are taxed more than others. Planning Tip #12 – Contribute the maximum amount to retirement accounts. Planning Tip #29 – Elderly people with highly appreciated assets may be best advised to simply hold on to these assets Planning Tip #13 – Convert traditional IRAs to a Roth IRA.Planning Tip #30 – Pay most of the deductible expenses for an estate in the same year that the remaining estate assets are distributed. Planning Tip #14 – Contribute to deferred compensation plans.Planning Tip #31 – High earner taxpayers may consider placing capital gains- producing investments into simple trusts. Planning Tip #15 – Invest in qualified annuities.Planning Tip #32 - Maximize the election under Code 663(b) to treat distributions made in the first 65 days in 2013 as 2012 distributions. Planning Tip #16 – Invest in life insurance policies.Planning Tip #33 – Establish a Charitable Remainder Trust Planning Tip #17 – Invest in oil and working gas interests. Planning Tip # 34 – To avoid the 3.8% Medicare tax on oil and gas working interests convert limited partnership interests to general partnership interests. 34 Planning Tips 63 64
PLANNING FOR THE 2013 TAX INCREASES Alan S. Gassman, Esq. Erica Good Pless, Esq. Companion Webinar for The Annihilation of Wealth 2013 October 18, 2012 Download ppt "PLANNING FOR THE 2013 TAX INCREASES Alan S. Gassman, Esq. Erica Good Pless, Esq. Companion Webinar for The."
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