Tax Planning

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Dramatictax increases scheduled to go into effect in 2013 make 2012 tax planningimperative. The following taxes may be impacted:


·        Notonly are the Bush Administration tax cuts set to expire, but a new 3.8 percentsurtax on investment income and a possible reinstated claw-back of itemizeddeductions could raise the tax rate on ordinary income to as high as aneffective 44.6 percent for some taxpayers. ·        Similarly,the tax rate on long-term capital gains could increase from 15 percent to 20percent and the rate on qualified dividends from 15 percent to an effective 44.6percent. ·        Finally,if Congress doesn’t take action, the federal estate tax rate will increase from35 percent to 55 percent and the exclusion amount will drop from $5,120,000 to$1,000,000.
Thisletter will suggest some ways to avoid or minimize the adverse effects of thesechanges. Planning for these likely tax changes is a major undertaking and manyclients are beginning the process now rather than waiting for the fallelections. This is prudent because the additional time will allow you to becomecomfortable with the gifting process and provide time to custom design trustsfor your family.
GainHarvesting
Formany taxpayers it will make sense to harvest capital gains in 2012 to takeadvantage of the current lower rates. You would sell appreciated capital assetsand immediately reinvest in the same or similar assets. You would then hold thenew assets until you would otherwise have sold them, so there would be nochange in your investment strategy.
Decidingwhether to use the strategy is not as simple as it might appear on the surface,however, because the lower tax rates must generally be weighed against a lossof tax deferral. By harvesting the gains in 2012 you would be paying a lowertax rate, but recognizing the gains earlier. The greater the differential intax rates and the shorter the time before the second sale the more favorablegain harvesting would be.
Insome cases, the correct decision will be clear without doing any analysis. Ifyou are currently in the 0% long-term capital gains bracket, 2012 gainharvesting would always be favorable because it would give you a free basisstep up. Gain harvesting would also be more favorable if you planned to sellthe stock in 2013 or 2014 anyway. The time value of the tax deferral would besmall compared with the future tax savings.
Atthe other extreme, if you are currently in the 15% long-term capital gainbracket and plan to die with an asset and pass it on to heirs with a stepped-upbasis, there is no reason to recognize the gain now. You would be incurring taxnow without any offsetting future benefit. Nor would it make sense to harvestlosses to create additional capital loss carryovers. These loss carryoverswould be better employed to offset capital gains in the future when rates areexpected to be higher.
Ifyou do not fall into one of these categories, you will have to do aquantitative analysis to determine whether 2012 gain harvesting would work foryou. The decision could be thought of as buying a future tax savings by recognizinggain in 2012. By analyzing the decision in this way, you could measure a returnon the 2012 investment over time. If this return on investment exceeded youropportunity cost of capital, gain harvesting would make sense. We have software that enables usto do this analysis quickly, easily and economically. Please contact usto find out which of your assets should be harvested in 2012.
Planningfor the 3.8 Percent Medicare Surtax
Fortax years beginning January 1, 2013, the tax law imposes a 3.8 percent surtaxon certain passive investment income of individuals, trusts and estates. Forindividuals, the amount subject to the tax is the lesser of (1) net investmentincome (NII) or (2) the excess of a taxpayer's modified adjusted gross income(MAGI) over an applicable threshold amount.
Netinvestment income includes dividends, rents, interest, passive activity income,capital gains, annuities and royalties. Specifically excluded from thedefinition of net investment income are self-employment income, income from anactive trade or business, gain on the sale of an active interest in apartnership or S corporation, IRA or qualified plan distributions and incomefrom charitable remainder trusts. MAGI is generally the amount you report on the last line of page 1,Form 1040.
Theapplicable threshold amounts are shown below.
Marriedtaxpayers filing jointly                             $250,000Marriedtaxpayers filing separately                       $125,000Allother individual taxpayers                               $200,000
Asimple 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 thebase 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 andor NII and reduce the base on which the surtax is paid. These include (1) RothIRA conversions, (2) tax exempt bonds, (3) tax-deferred annuities, (4) lifeinsurance, (5) rental real estate, (6) oil and gas investments, (7) timingestate and trust distributions, (8) charitable remainder trusts, (9)installment sales and maximizing above-the-line deductions. We would be happyto explain how these strategies might save you large amounts of surtax.
AcceleratingOrdinary Income into 2012
A final opportunity that should be noted isaccelerating ordinary income into 2012. Perhaps the best way to do this wouldbe to convert a traditional IRA to a Roth IRA in 2012, if a conversionotherwise made sense. Ordinary income could also be accelerated by sellingbonds with accrued interest in 2012 or selling and repurchasing bonds tradingat a premium. Finally, you might consider exercising non-qualified stockoptions in 2012.
EstateTax Provisions
Theestate tax exemption is currently $5,120,000 per person and will revert to$1,000,000 on January 1^st, 2013 unless Congress acts. ThePresident is suggesting a $3,500,000 exemption. The potential reduction inthe estate tax exemption is resulting in many client 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 youngergenerations. Most experts would define the savings at 35%, 45% or 55% ofthe amount gifted over $1,000,000. On a $5,000,000 gift the savings wouldbe $1,800,000 ($4,000,000*45%).
Weare prepared to assist you in modeling scenarios to determine which strategiesare right for you. Please don’t hesitate to call us at 801.269.1818 to schedulean appointment to begin discussing your options.