Planning Strategies in Wake of the
New 3.8% Medicare “Surtax”
Presented by:
Robert S. Keebler, CPA, MST, AEP (Distinguished)
Keebler & Associates, LLP
420 South Washington Street
Green Bay, WI 54301
Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained
in this communication, including attachments, was not written to be used and cannot be used for the purpose of (i) avoiding tax-related penalties
under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. If you
would like a written opinion upon which you can rely for the purpose of avoiding penalties, please contact us.
3.8% Medicare “Surtax” Overview
• Beginning with the 2013 tax year, a new 3.8%
•
Medicare “surtax” will apply to all taxpayers whose
income exceeds a certain “threshold amount”. This
new “surtax” will, in essence, raise the marginal
income tax rate for affected taxpayers.
Thus, a taxpayer in the 39.6% tax bracket (i.e. the
highest marginal income tax rate in 2013) would
have a marginal rate of 43.4%!
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3.8% Medicare “Surtax” Overview
Current Tax
Rate
Tax Rate in
2013+
Tax Rate in
2013+
(w/surtax)
10%
15%
15%
15%
25%
15%
28%
15%
28%
28%
31%
34.8%
33%
36%
39.8%
35%
39.6%
43.4%
NOTE: The chart above assumes that the 3.8% Medicare surtax would not begin to
apply until a person’s taxable income reaches the 31% tax bracket (based on certain
net investment income and itemized deduction assumptions). However, there are
times when the 3.8% could apply to a person in a lower tax bracket (i.e. 15%, 28%) or
may not apply to a person in higher tax brackets (31%, 36%, 39.6%).
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3.8% Medicare “Surtax” Overview
APPLICATION TO INDIVIDUALS – The new
Medicare surtax is equal to 3.8% times the lesser of
the following:
1. “Net investment income”, OR
2. The excess (if any) of –
a. “Modified adjusted gross income” (“MAGI”)
for such taxable year, over the
b. “Threshold amount”
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3.8% Medicare “Surtax” Overview
APPLICATION TO ESTATES AND TRUSTS – The new
Medicare surtax is equal to 3.8% times the lesser of the
following:
1. Undistributed “net investment income” for such
taxable year, or
2. The excess (if any) of –
a. “Adjusted gross income” (as defined in section
67(e) for such taxable year, over the
b. Dollar amount at which the highest tax bracket
in section 1(e) begins for such taxable year
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3.8% Medicare “Surtax” Overview
Three critical terms associated with the 3.8% Medicare
surtax:
• “Net investment income”
• “Threshold amount”
• “Modified adjusted gross income” (“MAGI”)
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3.8% Medicare “Surtax” Overview
Net Investment Income is defined as interest, dividends, annuities, rents,
royalties, income derived from a passive activity, and net capital gain
derived from the disposition of property (other than property held in an
active trade or business), reduced by deductions properly allocable to such
income.
Specifically, this does not include the following:
1.
2.
3.
4.
Income derived from an active trade or business;
Distributions from IRAs or their qualified plans;
Any income taken into account for self-employment tax purposes;
Gain on the sale of an active interest in a partnership or S corporation;
or
5. Items which are otherwise excluded or exempt from income under
income tax law, such as interest from tax-exempt bonds, capital gain
excluded under IRC §121, and veteran’s benefits.
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3.8% Medicare “Surtax” Overview
Types of Income Subject to Surtax
Subject to Surtax
Wages
Taxable Interest
Exempt Interest
Dividends
Annuity Income
Passive Royalty
Active Royalty
Rents
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Exempt from Surtax
X
X
X
X
X
X
X
X
8
3.8% Medicare “Surtax” Overview
“Threshold amount”: is the key factor in determining the “lesser of”
formula for purposes of calculating the surtax.
Threshold amounts
• Single taxpayers - $200,000
• Married taxpayers - $250,000
• Estates/trusts - $11,650 (i.e. top income tax bracket in 2012)
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3.8% Medicare “Surtax” Overview
“Modified adjusted gross income” (“MAGI”): is the amount
that is compared to the “threshold amount” to determine the
“net investment income” that is subject to the surtax.
MAGI equals:
• Adjusted gross income (i.e., Form 1040, Line 37) PLUS
• Net foreign earned income exclusion (i.e., gross income
excluded under the foreign earned income exclusion less
certain deductions or exclusions that were disallowed due to
the foreign earned income exclusion)
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3.8% Medicare “Surtax” Overview
Example 1: John, a single taxpayer, has $100,000 of salary and $50,000 of
net investment income for MAGI of $150,000. The 3.8% surtax would not
apply because his MAGI is less than $200,000.
Example 2: Linda, a single taxpayer, has $225,000 of net investment income
and no other source of income. The 3.8% surtax would apply to $25,000 of
income (the lesser of investment income of $225,000 or the excess of
$225,000 MAGI over $200,000 “threshold amount”).
Example 3: Terry & Tina, married filing jointly, have $300,000 of salaries and
no net investment income. The tax 3.8% surtax will not apply because they
have no investment income.
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3.8% Medicare “Surtax” Overview
Example 4: Peter & Paula, married filing jointly, have $400,000 of salaries
and $50,000 of net investment income. They will pay the 3.8% surtax on
$50,000.
Example 5: Sarah & Scott, married filing jointly, have $200,000 of salaries
and $150,000 of net investment income for total MAGI of $350,000. The 3.8%
surtax would apply to $100,000 of income (excess of $350,000 MAGI over
$250,000 threshold amount).
Example 6: Randy, a single taxpayer, age 69, has investment income of
$200,000 and is not subject to the surtax. In the following year, Randy has an
RMD from his IRA of $125,000. In this case $325,000 of MAGI exceeds the
$200,000 threshold and $125,000 is subject to the 3.8% surtax.
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3.8% Medicare “Surtax” Overview
Example 7: The John Smith Trust has investment income of $51,000 and
has made no distributions during the current tax year. In this case, $39,800
of income ($51,000 - $11,200 top bracket amount) will be subject to the
3.8% surtax.
Example 8: David and Veronica, married filing jointly, have pension and
IRA income and tax-exempt interest income. The 3.8% surtax does not
apply regardless of income because they have no “net investment income”.
Example 9: In 2012, Jill, age 60 and single, has wages of $200,000 and
taxable interest income from CDs of $100,000. During 2012 Jill moves half
of her investments into an annuity and purchases a life insurance policy
with the remaining CDs. Because of this planning, in 2013 all of her interest
income is sheltered in either the annuity or the life insurance policy. Thus,
Jill is not subject to the 3.8% surtax.
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3.8% Medicare “Surtax” Overview
Example 10: The Anita Jones Trust has net investment income of $100,000
and made a distribution of 100% of that income during the current tax year. In
this case, the trust will not be subject to the 3.8% surtax (but the trust
beneficiaries might be subject to the 3.8% surtax based on their own tax
situations).
Example 11: Gary and Barb, married filing jointly, have $130,000 of pension
income and $115,000 of net investment income. Further, Gary withdrew
$50,000 from his Roth IRA. Given these facts, none of the investment income
is subject to the 3.8% surtax because Gary and Barb’s MAGI ($245,000) was
below the $250,000 threshold amount.
Example 12: Same facts as Example 11, except that Gary withdrew $50,000
from his traditional IRA. In this situation, $45,000 [($130,000 + $115,000 +
$50,000) - $250,000] of net investment income would be subject to the 3.8%
surtax.
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Planning Around the “Surtax”
Strategies for Reducing “Net Investment Income”
•
•
•
•
•
•
•
Municipal bonds
Tax-deferred annuities
Life insurance
Rental real estate
Oil & gas investments
Choice of accounting year for estate/trust
Timing of estate/trust distributions
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Planning Around the “Surtax”
Strategies for Reducing “Net Investment Income”
Municipal Bond Example
Jacob, a single taxpayer, on average has $180,000 of salary income,
$5,000 of interest income and $15,000 of dividend income each year.
Recently, Jacob inherited $1,000,000 from his uncle and has determined
that he would like to invest the money either in: (a) taxable corporate bonds
earning 7% or (b) tax-exempt municipal bonds earning 4.5%. Assuming that
Jacob is in the 36% marginal income tax bracket for the 2013 tax year and
lives in a state without an income tax, below is a summary of the after-tax
yield on each investment:
Corporate bond
4.214%
Municipal bond
4.5%
{7% x [1 – (36% + 3.8%)]}
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Planning Around the “Surtax”
Strategies for Reducing “Net Investment Income”
Tax-Deferred Annuity Example
Lisa, a single taxpayer, has recently been approached by her financial advisor to
consider investing in a tax-deferred non-qualified annuity. At the advice of her CPA,
Lisa decided to invest $500,000 in a tax- deferred non-qualified annuity earning 5%
per year. Assuming that Lisa has $200,000 of gross income and is in the 28% tax
bracket for the next 10 years, below is a summary of the tax savings achieved by
investing in a tax-deferred non-qualified annuity versus investing in a non-qualified
diversified investment portfolio (i.e. a taxable brokerage account) earning 6% interest
per year on a pre-tax basis.
Taxable Brokerage Account
Year
1
2
3
4
5
6
7
8
9
10
Beginning
Balance
$ 500,000
$ 520,460
$ 541,757
$ 563,926
$ 587,002
$ 611,022
$ 636,025
$ 662,051
$ 689,142
$ 717,342
Income @
6%
$ 30,000
$ 31,228
$ 32,505
$ 33,836
$ 35,220
$ 36,661
$ 38,161
$ 39,723
$ 41,349
$ 43,041
Income Tax
@ 31.8%
$ (9,540)
$ (9,930)
$ (10,337)
$ (10,760)
$ (11,200)
$ (11,658)
$ (12,135)
$ (12,632)
$ (13,149)
$ (13,687)
Ending
Balance
$ 520,460
$ 541,757
$ 563,926
$ 587,002
$ 611,022
$ 636,025
$ 662,051
$ 689,142
$ 717,342
$ 746,696
Tax-Deferred Non-Qualified Annuity
Beginning
Balance
$ 500,000
$ 525,000
$ 551,250
$ 578,813
$ 607,753
$ 638,141
$ 670,048
$ 703,550
$ 738,728
$ 775,664
Income @
5%
$ 25,000
$ 26,250
$ 27,563
$ 28,941
$ 30,388
$ 31,907
$ 33,502
$ 35,178
$ 36,936
$ 38,783
Income Tax
@ 0.00%
$
$
$
$
$
$
$
$
$
$
-
Ending
Balance
$ 525,000
$ 551,250
$ 578,813
$ 607,753
$ 638,141
$ 670,048
$ 703,550
$ 738,728
$ 775,664
$ 814,447
NOTE: The 31.8% income tax rate in the taxable brokerage account scenario is the sum of Lisa’s marginal
income tax rate (28%) plus the 3.8% surtax because her gross income was over the threshold amount.
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Difference
$
4,540
$
9,493
$ 14,887
$ 20,751
$ 27,119
$ 34,023
$ 41,499
$ 49,586
$ 58,322
$ 67,752
Planning Around the “Surtax”
Strategies for Reducing “Net Investment Income”
Life Insurance Example
• Tim, a married-filing-jointly taxpayer, recently paid a $250,000 single premium to
purchase a $2,000,000 second-to-die whole-life life insurance policy. At the end
of Year 10, Tim withdrew $50,000 from the policy’s cash value when it was worth
$450,000.
• Given these facts, none of the $200,000 of earnings to-date ($450,000 current
cash value - $250,000 initial premium), or any future earnings within the life
insurance policy, are subject to the 3.8% surtax until Tim withdraws more than
his initial single premium amount.
• Further, even if Tim withdraws earnings from the life insurance policy in a future
tax year, none of the earnings will be subject to the 3.8% surtax, provided that
Tim’s MAGI (which would include the earnings withdrawn from the life insurance
policy) is below the “threshold amount” (i.e. $250,000 for married-filing-jointly
taxpayers).
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Planning Around the “Surtax”
Strategies for Reducing “Net Investment Income”
Rental Real Estate Example
Jerry & Mary, married-filing-jointly taxpayers, have $50,000 of net royalty income annually from a gas well
in Wyoming. In addition, Jerry has $100,000 in wages, Mary has $75,000 in wages and the both of them
have $30,000 in dividend income each year.
At the end of 2012, Jerry & Mary invested $275,000 into a residential real estate property. Based on past
results, on average the property value increases by about 3.5% per year and the rental brings in about
$5,000 of net income before depreciation. Assuming that the property is depreciated over a 27½-year life,
the $275,000 investment will produce a $10,000 annual depreciation expense, resulting in a net rental
loss of $5,000. This resulting net rental loss can then be used to offset Jerry & Mary’s net royalty income.
Assuming that Jerry and Mary are in the 31% income tax bracket in 2013, below is a summary of the
return on investment earned by Jerry & Mary’s from their rental real estate property.
Property appreciation
Net cash flow from rental
Income tax savings from rental loss
Surtax savings from rental loss
Total return on investment
$9,625 ($275,000 x 3.5%)
5,000
1,550 ($5,000 x 31%)
190 ($5,000 x 3.8%)
$16,365
Total return on investment (%)
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5.95% ($16,365/$275,000)
19
Planning Around the “Surtax”
Strategies for Reducing “Net Investment Income”
Oil & Gas Investment Example
• George, a single taxpayer, recently invested $100,000 in a working interest in an
oil well. According to the oil well driller’s accountants, 80% of the initial
investment can be deducted in the first year as an “intangible drilling cost”
(“IDC”). Assuming that George has $80,000 of net investment income subject to
the 3.8% surtax and is in the 36% marginal income tax bracket, below is a
summary of the total tax savings from the oil well investment.
Income tax savings from IDC deduction
Surtax savings from IDC deduction
Total tax savings
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$28,800 [($100,000 x 80%) x 36%]
3,040 [($100,000 x 80%) x 3.8%]
$31,840
20
Planning Around the “Surtax”
Strategies for Reducing “Net Investment Income”
Choice of Accounting Year Example
On February 10, 2012, Patricia passed away. During the course of the 2012
tax year, Patricia’s estate had $50,000 of net investment income, $600 of
miscellaneous non-investment income and no deductible expenses. In
January 2013, the executor of Mary’s estate was trying to determine
whether the estate should elect a calendar year-end (i.e. December 31,
2012) or a fiscal year-end (i.e. January 31, 2013).
Assuming a top marginal tax bracket amount of $12,000 in 2013, if the
executor were to choose a calendar year-end of December 31, 2012, the
estate would save $1,440 [($50,000 - $12,000) x 3.8%] in surtax.
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Planning Around the “Surtax”
Strategies for Reducing “Net Investment Income”
Trust/Estate Distribution Example
During the 2013 tax year, the Smith Family Trust had $100,000 of net
investment income and $19,900 of deductible expenses. The trustee is now
trying to decide if a distribution of trust accounting income should be made to
the trust beneficiaries. Assuming that each of the trust beneficiaries is
currently in the 28% tax bracket and each has gross income below the
Medicare surtax “threshold amount”, below is a summary of the tax savings
that would occur if an $80,000 distribution was made:
Gross Income
Less: Deductible Expenses
Adjusted Total Income
Less: Income Distribution Deduction
Less: Exemption
Taxable Income
No
$80K
Distribution
Distribution
$
100,000 $
100,000
(19,900)
(19,900)
$
80,100 $
80,100
(80,000)
(100)
(100)
$
80,000 $
-
Income Tax @ Trust Level
Income Tax @ Beneficiary Level
Total Income Tax
$
Medicare Surtax @ Trust Level
Medicare Surtax @ Beneficiary Level
Total Medicare Surtax
$
Total Taxes
$
$
$
2,614
2,614
$
33,021
$
12,000
$
21,021
$
SAVINGS
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30,407
30,407
22
$
$
12,000
12,000
-
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
•
•
•
•
Roth IRA conversions
Charitable remainder trusts (CRTs)
Non-grantor charitable lead trusts (CLTs)
Installment sales
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Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions
Roth IRA benefits
• Lowers overall taxable income long-term
• Tax-free compounding
• No RMDs at age 70½
• Tax-free withdrawals for beneficiaries
• More effective funding of the “bypass trust”
PURPOSE OF STRATEGY (as it relates to the 3.8% surtax): To lower
MAGI below the “threshold amount” over the long-term.
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Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions
In simplest terms, a traditional IRA will produce the same after-tax
result as a Roth IRA provided that:
• The annual growth rates are the same
• The tax rate in the conversion year is the same as the tax rate during
the withdrawal years (i.e. A x B x C = D; A x C x B = D)
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Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions
Current Account Balance
Less: Income Taxes @ 40%
Net Balance
Traditional IRA
Roth IRA
$
100,000 $
100,000
(40,000)
$
100,000 $
60,000
Growth Until Death
Account Balance @ Death
Less: Income Taxes @ 40%
Net Account Balance to Family
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200.00%
$
$
26
300,000 $
(120,000)
180,000 $
200.00%
180,000
180,000
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions
Critical decision factors
• Tax rate differential (year of conversion vs. withdrawal
•
•
•
years)
Use of “outside funds” to pay the income tax liability
Need for IRA funds to meet annual living expenses
Time horizon
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Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions
The key to successful Roth IRA conversions is to keep as much of
the conversion income as possible in the current marginal tax bracket
• However, there are times when it may make sense to convert more
and go into higher tax brackets
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Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions
“Optimum” Roth IRA
conversion amount
35% tax
bracket
Target Roth IRA
conversion amount
33% tax
bracket
Current
taxable
income
28% tax
bracket
25% tax
bracket
15% tax
bracket
10% tax
bracket
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Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions – Chart #1 (50-Year-Old)
After-Tax Investment Balance
(Tax Rates Remain the Same)
$4,660,957
$4,232,738
$4,232,738
$3,172,169
$2,946,623
$2,053,290
$2,053,290
$2,946,623
$2,158,925
10
15
20
Year
Traditional IRA
Roth IRA Conversion (Pay Tax w/Roth IRA)
Roth IRA Conversion (Pay Tax w/Outside Account)
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Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions – Chart #2 (50-Year-Old)
After-Tax Investment Balance
(Lower Tax Rates in Future Years)
$4,698,834
$4,660,957
$4,232,738
$3,263,840
$3,172,169
$2,946,623
$2,269,183
$2,053,290
$2,158,925
10
15
20
Year
Traditional IRA
Roth IRA Conversion (Pay Tax w/Roth IRA)
Roth IRA Conversion (Pay Tax w/Outside Account)
ASSUMPTIONS
IRA Owner's Age
IRA Balance
Outside Account Balance
Yield Rate
Growth Rate
Total Return (Pre-Tax)
Less: Income Tax on Yield @ 40%
Less: Income Tax on Growth @ 20%*
Total Return (After-Tax)
Tax Rate - Current Year
Tax Rate - Future Years
* Assumes 50% annual turnover on growth
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50
$
$
1,000,000
400,000
2.00%
6.00%
8.00%
-0.80%
-0.60%
6.60%
40.00%
30.00%
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions – Chart #3 (50-Year-Old)
After-Tax Investment Balance
(Higher Tax Rates in Future Years)
$5,019,998
$4,698,834
$4,232,738
$3,263,840
$3,432,999
$2,946,623
$2,269,183
$2,348,409
$2,053,290
10
15
20
Year
Traditional IRA
Roth IRA Conversion (Pay Tax w/Roth IRA)
Roth IRA Conversion (Pay Tax w/Outside Account)
ASSUMPTIONS
IRA Owner's Age
IRA Balance
Outside Account Balance
Yield Rate
Growth Rate
Total Return (Pre-Tax)
Less: Income Tax on Yield @ 40%
Less: Income Tax on Growth @ 20%*
Total Return (After-Tax)
Tax Rate - Current Year
Tax Rate - Future Years
* Assumes 50% annual turnover on growth
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50
$
$
1,000,000
400,000
2.00%
6.00%
8.00%
-0.80%
-0.60%
6.60%
30.00%
40.00%
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions – Chart #4 (70-Year-Old)
After-Tax Investment Balance
(Tax Rates Remain the Same)
$4,660,957
$4,232,738
$4,020,684
$3,172,169
$2,864,468
$2,028,696
$2,053,290
$2,946,623
$2,158,925
10
15
Year
20
ASSUMPTIONS
IRA Owner's Age
IRA Balance
Outside Account Balance
Traditional IRA
Roth IRA Conversion (Pay Tax w/Roth IRA)
Roth IRA Conversion (Pay Tax w/Outside Account)
Yield Rate
Growth Rate
Total Return (Pre-Tax)
Less: Income Tax on Yield @ 40%
Less: Income Tax on Growth @ 20%*
Total Return (After-Tax)
Tax Rate - Current Year
Tax Rate - Future Years
* Assumes 50% annual turnover on growth
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70
$
$
1,000,000
400,000
2.00%
6.00%
8.00%
-0.80%
-0.60%
6.60%
40.00%
40.00%
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions – Chart #5 (70-Year-Old)
After-Tax Investment Balance
(Lower Tax Rates in Future Years)
$4,660,957
$4,451,437
$4,232,738
$3,172,169
$3,167,993
$2,946,623
$2,240,489
$2,053,290
$2,158,925
10
15
20
Year
ASSUMPTIONS
IRA Owner's Age
Traditional IRA
Roth IRA Conversion (Pay Tax w/Roth IRA)
Roth IRA Conversion (Pay Tax w/Outside Account)
IRA Balance
Outside Account Balance
Yield Rate
Growth Rate
Total Return (Pre-Tax)
Less: Income Tax on Yield @ 40%
Less: Income Tax on Growth @ 20%*
Total Return (After-Tax)
Tax Rate - Current Year
Tax Rate - Future Years
* Assumes 50% annual turnover on growth
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34
70
$
$
1,000,000
400,000
2.00%
6.00%
8.00%
-0.80%
-0.60%
6.60%
40.00%
30.00%
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Roth IRA Conversions – Chart #6 (70-Year-Old)
After-Tax Investment Balance
(Higher Tax Rates in Future Years)
$5,019,998
$4,698,834
$4,020,684
$3,263,840
$3,432,999
$2,864,468
$2,028,696
$2,269,183
$2,348,409
10
15
20
ASSUMPTIONS
IRA Owner's Age
Year
IRA Balance
Outside Account Balance
Traditional IRA
Roth IRA Conversion (Pay Tax w/Roth IRA)
Roth IRA Conversion (Pay Tax w/Outside Account)
Yield Rate
Growth Rate
Total Return (Pre-Tax)
Less: Income Tax on Yield @ 40%
Less: Income Tax on Growth @ 20%*
Total Return (After-Tax)
Tax Rate - Current Year
Tax Rate - Future Years
* Assumes 50% annual turnover on growth
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35
70
$
$
1,000,000
400,000
2.00%
6.00%
8.00%
-0.80%
-0.60%
6.60%
30.00%
40.00%
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Charitable Remainder Trust (CRT)
A Charitable Remainder Trust (CRT) is a split interest trust consisting of
an income interest and a remainder interest. During the term of the
trust, the income interest is usually paid out to the donor (or some other
named beneficiary). At the end of the trust term, the remainder
(whatever is left in the trust) is paid to the charity or charities that have
been designated in the trust document.
PURPOSE OF STRATEGY (as it relates to the 3.8% surtax): To
harbor “net investment income” in a tax-exempt environment while at
the same time leveling income over a longer period of time to keep
MAGI below the “threshold amount”.
Personal Financial Planning Section
36
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Charitable Remainder Trust (CRT)
Donor
(Income Beneficiary)
Donor receives an
immediate income tax
deduction for present
value of the remainder
interest (must be at least
10% of the value of the
assets originally
contributed)
Transfer of highlyappreciated assets
CRT
Annual (or more
frequent) payments
for life (or a term of
years)
At the donor’s death (or at
the end of the trust term),
the charity receives the
residual assets held in the
trust
Public
Charity
(Remainder Beneficiary)
37
Personal Financial Planning Section
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Charitable Remainder Trust (CRT)
Two Main Types of CRTs
Charitable Remainder Annuity Trust (CRAT) – the beneficiaries receive a
stated amount of the initial trust assets each year.
• The amount received is established at the beginning of the trust and will not
change during the term of the trust regardless of investment performance
(unless inadequate investment performance causes the trust to run out of
assets)
Charitable Remainder Unitrust (CRUT) – the income beneficiaries receive a
stated percentage of the trust’s assets each year.
• The distribution will vary from year to year depending on the investment
performance of the trust assets and the amount withdrawn
Personal Financial Planning Section
38
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Charitable Remainder Trust (CRT)
•
•
•
Special Considerations
Annual payout can neither be less than 5% nor more than
50%.
The present value of the remainder interest must be at least
10% of the value of the assets contributed to the trust.
The trust term cannot be more than 20 years (if a term interest
is used)
Personal Financial Planning Section
39
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Charitable Lead Trust (CLT)
A Charitable Lead Trust (CLT) is a split interest trust consisting of an
income interest and a remainder interest. During the term of the trust, the
income interest is paid out to a named charity. At the end of the trust term,
the remainder (whatever is left in the trust) is paid to non-charitable
beneficiaries (e.g. children of the donor) that have been designated in the
trust document.
PURPOSE OF STRATEGY (as it relates to the 3.8% surtax): To offset
“net investment income” against charitable deductions dollar-for-dollar in
a tax-efficient manner.
Personal Financial Planning Section
40
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Charitable Lead Trust (CLT)
Donor
Transfer of cash, stock
and/or other assets
(Income Beneficiary)
CLT
Annual (or more
frequent) payments for
life (or a term of years)
At the donor’s death (or at
the end of the trust term),
the remainder beneficiaries
receive the residual assets
held in the trust
Donor’s Children
41
(Remainder Beneficiary)
Personal Financial Planning Section
Public
Charity
(Income Beneficiary)
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Charitable Lead Trust (CLT)
Two Main Types of CLTs
Charitable Lead Annuity Trust (CLAT) – The charitable
beneficiary receives a stated amount of the initial trust assets
each year.
• The amount received is established at the beginning of the trust and will
not change during the term of the trust regardless of investment
performance (unless inadequate investment performance causes the trust
to run out of assets)
Charitable Lead Unitrust (CLUT) – The charitable beneficiary
receives a stated percentage of the trust’s assets each year.
• The distribution will vary from year to year depending on the investment
performance of the trust assets and the amount withdrawn
Personal Financial Planning Section
42
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Installment Sale
An installment sale is a type of sale in which the seller sells an asset to
another person in exchange for a promissory note paid over a period of
time. If executed correctly, the taxable gain recognized by the seller will be
deferred until payments are made on the principal of the note.
PURPOSE OF STRATEGY (as it relates to the 3.8% surtax): To level
“net investment income” over a longer period of time so as to keep MAGI
below the “threshold amount”.
Personal Financial Planning Section
43
Planning Around the “Surtax”
Strategies for Reducing “MAGI”
Installment Sale
Sale of highly-appreciated asset
Seller
Promissory note paid over a
period of years
Taxable gain is deferred
until payments on
principal are made
Personal Financial Planning Section
44
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Personal Financial Planning Section
45
PFP Section Resources (aicpa.org/PFP)
Series: Proactive Planning in Preparation for 2013
• Access the seminar recording and slide decks from the following
2 web seminars at aicpa.org/PFP/webseminars
- Proactive Planning in Preparation for 2013 (5/7)
- Investment Strategies in Preparation for 2013 (5/29)
• Upcoming web seminars in Proactive Planning in Preparation
for 2013 series:
- Estate Planning Strategies In-Depth (date TBD)
- Post Election: What Now?
Visit aicpa.org/PFP/proactiveplanning for more resources
Personal Financial Planning Section
46
New Keebler Chart on Gain Harvesting
Available to PFP/PFS members
Personal Financial Planning Section
47
New Toolkit from Bob Keebler!
Preparing Your Client for the 2013 Tax Increases:
Tools, Tips and Tactics
Get up to speed quickly and educate your clients on the
forces shaping the individual tax landscape right now.
The information and resources on this multimedia toolkit
will enable you to help your individual clients make good
decisions and implement practices that will yield benefits
in 2013.
PFP/PFS members pay $59 for this toolkit (a savings
of more than 50% off of the regular price)
Available on www.CPA2Biz.com
Personal Financial Planning Section
48
Circular 230 Disclosure
Pursuant to the rules of professional conduct set forth in Circular 230, as
promulgated by the United States Department of the Treasury, nothing contained in
this communication was intended or written to be used by any taxpayer for the
purpose of avoiding penalties that may be imposed on the taxpayer by the Internal
Revenue Service, and it cannot be used by any taxpayer for such purpose. No
one, without our express prior written permission, may use or refer to any tax
advice in this communication in promoting, marketing, or recommending a
partnership or other entity, investment plan or arrangement to any other party.
For discussion purposes only. This work is intended to provide general information
about the tax and other laws applicable to retirement benefits. The author, his firm
or anyone forwarding or reproducing this work shall have neither liability nor
responsibility to any person or entity with respect to any loss or damage caused, or
alleged to be caused, directly or indirectly by the information contained in this work.
This work does not represent tax, accounting, or legal advice. The individual
taxpayer is advised to and should rely on their own advisors.
Personal Financial Planning Section
49