Huge Income and EstateTax Increases are Scheduled for 2103 so Tax Planning in 2013 is More Important than Ever Says Jim Ferguson, CPA, PFS, CEPA with Rock Bridge, LLC

Share Article

Many income tax provisions are scheduled to expire at the end of 2012. Tax rates are scheduled to increase and new taxes related to the new health care laws will become effective. Estate tax rates are scheduled to jump dramatically and the lifetime exemption is scheduled to drop from $5,120,000 to $1,000,000 per person. Planning is essential.

Professional, Unbiased Advice

The following taxes may be impacted:

1. The Bush tax cuts are scheduled to expire and a new 3.8% surtax on investment income and possible claw-back of itemized deductions could raise the tax rate on ordinary income to as high as an effective 44.6% rate for some taxpayers.

2. The tax rate on long-term capital gains could increase from 15% to 20% and the rate on qualified dividends could increase from 15% to 44.6%

3. If Congress doesn't take action, the federal estate tax rate will increase from 35% to 55% and the lifetime exclusion per person will drop from $5,120,000 to $1,000,000.

Here are some suggestions for ways to minimize the adverse consequences of these changes:

Gain Harvesting

It may make sense for many taxpayers to harvest capital gains in 2012 to take advantage of the current lower rates. Appreciated capital assets would be sold in 2012 and the same or similar assets would be immediately repurchased. These assets would be held until the original scheduled date for their sale, so there is no change in the investment strategy.

Deciding to use this strategy is not as simple as it might appear. The lower tax rates must be weighed against the loss of tax deferral. The greater the differential in tax rates and the shorter the time before the second sale, the more favorable gain harvesting will be.

Planning for the 3.8% Medicare Surtax

Beginning January 1, 2013, the tax law imposes a 3.8% surtax on certain passive investment income of individuals, trusts and estates. For individuals, the amount subject to the tax is the lesser of (1) net investment income (NII) or (2) the excess of a taxpayer's modified adjusted gross income (MAGI) over an applicable threshold amount.

Net investment income includes dividends, rents, interest, passive activity income, capital gains, annuities and royalties. Specifically excluded from the definition of net investment income are self-employment income, income from an active trade or business, gain on the sale of an active interest in a partnership or S corporation, IRA or qualified plan distributions and income from charitable remainder trusts. MAGI is generally the amount you report on the last line of page 1, Form 1040.

The applicable threshold amounts are shown below.

Married taxpayers filing jointly            $250,000
Married taxpayers filing separately        $125,000
All other individual taxpayers            $200,000

A simple example will illustrate how the tax is calculated.

Example. Al and Barb, married taxpayers filing separately, have $300,000 of salary income and $100,000 of NII. The amount subject to the surtax is the lesser of (1) NII ($100,000) or (2) the excess of their MAGI ($400,000) over the threshold amount ($400,000 -$250,000 = $150,000). Because NII is the smaller amount, it is the base on which the tax is calculated. Thus, the amount subject to the tax is $100,000 and the surtax payable is $3,800 (.038 x $100,000).

Fortunately, there are a number of effective strategies that can be used to reduce MAGI and or NII and reduce the base on which the surtax is paid. These include (1) Roth IRA conversions, (2) tax exempt bonds, (3) tax-deferred annuities, (4) life insurance, (5) rental real estate, (6) oil and gas investments, (7) timing estate and trust distributions, (8) charitable remainder trusts, (9) installment sales and maximizing above-the-line deductions. We would be happy to explain how these strategies might save you large amounts of surtax.

Accelerating Ordinary Income into 2012

A final opportunity that should be noted is accelerating ordinary income into 2012. Perhaps the best way to do this would be to convert a traditional IRA to a Roth IRA in 2012, if a conversion otherwise made sense. Ordinary income could also be accelerated by selling bonds with accrued interest in 2012 or selling and repurchasing bonds trading at a premium. Finally, consider exercising non-qualified stock options in 2012.

Estate Tax Provisions

The estate tax exemption is currently $5,120,000 per person and will revert to $1,000,000 on January 1st, 2013 unless Congress acts. The President is suggesting a $3,500,000 exemption. The potential reduction in the estate tax exemption is resulting in many clients making large gifts in trust, for their family. In some instances, the trusts are for the spouse, children and grandchildren and in others just for children and younger generations. Most experts would define the savings at 35%, 45% or 55% of the amount gifted over $1,000,000. On a $5,000,000 gift the savings would be $1,800,000 ($4,000,000*45%).

Jim Ferguson, CPA, PFS, CEPA, with Rock Bridge, LLC says that now is the time to start looking into these tax planning strategies so there is time to implement the solutions. Don't wait until after the elections to begin, that will be too late.

Share article on social media or email:

View article via:

Pdf Print

Contact Author

Jim Ferguson, CPA, PFS, CEPA
Visit website