PLANNING FOR THE
2013 TAX INCREASES
Alan S. Gassman, Esq.
agassman@gassmanpa.com
Erica Good Pless, Esq.
epless@law.stetson.edu
Companion Webinar for The Annihilation of Wealth 2013
October 18, 2012
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
2012
2013
2013 Medicare Tax
2013 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 Income
35%
39.6%
3.8%
43.4%
Additional .9% on
wages exceeding
$200,000 for single
taxpayers and
$250,000 or married
taxpayers.
3.8% total
Employment Taxes
Employer: 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.)
FICA/FUTA Taxes
6.2% 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.
$5,120,000
Exemption
35% Rate
$1,000,000
55% Rate
Estate Tax
12.4% on wages up to
the wage base.
N/A
55%
2
34 Planning Tips
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 2013.
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 gainsproducing 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.
3
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
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
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
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
2013
7
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 2013. 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 2013.
8
2013 Tax Increases – Individuals
SINGLE TAXPAYERS
2012
2013
If taxable income is
between:
Tax imposed
If taxable income is
between: (estimated*)
Tax imposed
$0 and $8,700
10%
N/A
N/A
$8,700 and $35,350
$870 + 15% of the excess
over $8,700
$0 and $35,800
15%
$35,351 and $85,650
$4,867.50 + 25% of the
excess over $35,350
$35,801 and $86,800
$5,370 + 28% of the
excess over $35,800
$85,651 and $178,650
$17,442.50 + 28% of $86,801 and $181,050
excess over $85,650
$19,650 + 31% of the
excess over $86,800
$178,651 and $388,350
$43,482.50 + 33% of the
excess over $178,650
$48,867.5 + 36% of the
excess over $181,050
$388,351 and above
$112,683.50 + 35% of the $393,651 and above
excess over $388,350
$181,051 and $393,650
$125,403 + 39.6% of the
excess over $393,650
*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 2012.
9
2013 Tax Increases – Individuals
MARRIED TAXPAYERS
2012
2013
If taxable income is
between:
Tax imposed
If taxable income is
between: (estimated*)
Tax imposed
$0 and $17,400
10%
N/A
N/A
$17,401 and $70,700
$1,740 + 15% of excess
over $17,400
$0 and $71,650
15%
$70,701 and $142,700
$9,735 + 25% of excess
over $70,700
$71,651 and $144,650
$10,747.5 + 28% of the
excess over $71,650
$142,701 and $217,450
$27,735 + 28% of excess
over $142,700
$144,651 and $220,400
$31,187 + 31% of the
excess over $144,650
$217,451 and $388,350
$48,665 + 33% of excess
over $217,450
$220,401 and $393,650
$54,669 + 36% of the
excess over $220,400
$388,351 and above
$105,062 + 35% of excess $393,651 and above
over $388,350
$117,038 + 39.6% of the
excess over $393,650
*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 2012.
10
2013 Tax Increases – Individuals
• Long-term capital gains are presently taxed at 15%, but
will increase to 20% in 2013.
• 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 2001.
• 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
2013 Tax Increases – Individuals
2012
2013
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
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 2013.
13
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 10,250,000
• 3.8% 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 2012.
14
2013 Tax Increases – Individuals
Deduction/Credit
AGI Phase-out
Available in 2012?
Available in 2013?
Expanded student loan interest
deduction
Expanded Adoption credit
$75,000 for single filers
$155,000 for married joint filers
YES
NO
2011 phase-out: $225,210
2012 phase-out: $229,710
YES
NO
Child tax credit
$75,000 for single filers
$110,00 for married filers
YES
NO
American Tax Credit
$90,000 for single filers
$180,000 for married joint filers
YES
NO
Elimination of Itemized
Deduction Limit
$50,000 for single filers
$100,000 for married joint filers
(adjusted for inflation)
$125,000 for single filers
$250,000 for married joint filers
YES
NO
NO
NO
$54,500 for single filers
$109,000 for married joint filers
NO
NO
$80,000 for single filers
$160,000 for married joint filers
NO
NO
NO
NO
NO
NO
State and local sales tax
deduction
Mortgage insurance premium
deduction
Tuition and fees deduction
Deduction
for
IRA N/A
contribution up to $100,000 to
charity
N/A
Teacher's supplies deduction
AMT Patch
$33,750 for single filers
$45,000 for married joint filers
NO
NO
Mass Transportation benefit
N/A
NO
NO
Home energy credit
N/A
NO
NO
15
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 taxpayer’s 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) John’s 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
16
that does not exceed $175,000 and 28% of the remaining excess.
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
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 2013. Double whammy!
18
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 selfemployment 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
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 2013.
• $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
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
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
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
$3,800.
23
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
2013 Tax Increases – Individuals
Type of Income
Subject to 3.8% tax?
YES
Interest and Dividends
X
Net Capital Gains
X
Royalties and net rental income
X
Installment sales proceeds
X
Gain from the sale of personal residence
in excess of the IRC § 121 exclusion
Passive income from S corporations
X
Passive activity income
X
Income from a trade or business that
trades in financial instruments or
commodities (hedge fund)
Active income from S corporations
X
NO
X
X
Wages
X
Income from qualified pension, profitsharing plan and stock bonus plans
Social Security Income
X
Tax Exempt Interest
X
X
25
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
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
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 + 10,000 (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
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 2012. Since this is expected to go up to 39.6% in 2013, ROTH IRA
conversions should be completed before the end of 2012.
•
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
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 2013.
– 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 2013.
30
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
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
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 2013.
33
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
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
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
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
2013 Tax Increases – Corporations
Effective Tax Rates for C Corporation
Taxable Income
Income Taxes
Effective tax rate
$335,000
$113,900
34%
$10,000,000
$3,400,000
34%
$15,000,000
$5,150,000
34.33%
$18,333,333
$6,416,667
35%
38
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
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 36.79 cents for each one dollar earned by the corporation.
40
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 2013. [(63.21 - 44.75) /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
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 2013.
42
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
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
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
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
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
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 arm’s 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
2013 Tax Increases – Corporations
S CORPORATION
OWNS AND MANAGES RENTAL REAL
ESTATE
$200,000 K-1 INCOME
SHAREHOLDER A
(qualifies as real
estate
professional)
$200,000 K-1 INCOME
SHAREHOLDER B
(passive investor)
49
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.
• A’s 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
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% = $900
• 3.8% 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 2013.
51
2013 Tax Increases – Corporations
179 deduction limit
Limit on purchases
Bonus Depreciation
2009
$250,000
$800,000
50%
2010
$500,000
$2,000,000
50% for property placed in
service before 9/8/10 and
100% for property placed
in service after 9/8/2010
2011
$500,000
$2,000,000
100%
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
$200,000
0% for most property
50% for certain property
with useful life of 10 years
or more and transportation
property
52
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 $200,000.
53
2013 Tax Increases – Trusts and Estates
Current income tax rates for trusts
Taxable income
Tax
$0-$2,400
15%
$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 +
$3,011.50 plus 35% of the excess over
$11,650
54
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 $33,934.
55
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
2013 Tax Increases – Trusts and Estates
TRUST
$300,000 undistributed
net investment income
BENEFICIARY A
(Single TP, MAGI =
$150k)
BENEFICIARY B
(Married TP,
MAGI = $500k)
57
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 150,000
•
3.8% x 150,000 = $5,700
58
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
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 2013.
–
–
•
$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
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 charity’s 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
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 2012.
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
34 Planning Tips
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 2013.
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 gainsproducing 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.
63
PLANNING FOR THE
2013 TAX INCREASES
Alan S. Gassman, Esq.
agassman@gassmanpa.com
Erica Good Pless, Esq.
epless@law.stetson.edu
Companion Webinar for The Annihilation of Wealth 2013
October 18, 2012