Some Peaks and Valleys Beyond the Fiscal Cliff

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1 Some Peaks and Valleys Beyond the Fiscal Cliff A Synopsis of Selected Provisions of the American Taxpayer Relief Act of 2012 Presented for Kingdom Advisors February 7, 2013, Orlando, Florida By Joseph H. Mitchiner, Attorney Table of Contents I Income Tax Changes, including AMT... 3 II Phase Outs for Itemized Deductions and Personal Exemptions... 4 III Medicare Surtax on Earnings and Investment Income... 5 IV IRA Direct Transfers to Charity (Qualified Charitable Distribution)...6 V Estate, Gift and Generation Skipping Transfer Taxes, including Portability... 6 VI Tax Strategies for Estates under $5.25 million ($10.5 million for portable couples) 8 VII Tax Strategies for Estates over $5.25 million ($10.5 million for portable couples)..10 VIII Some Extensions Regarding Businesses and Real Estate IX Some Extensions Regarding Education Plans X Retirement Plan Conversion...12 XI Iceberg Concept...13 XII Mitchiner Biography...14 Beyond the Fiscal Cliff Page 1 of 14

2 Internal Revenue Service Circular 230 Disclosure Pursuant to U.S. Treasury Department Regulations (Title 31 Code of Federal Regulations, Subtitle A, Part 10, revised as of June 20, 2005), you are advised that any federal tax advice contained in this communication, including attachments and enclosures, is not intended or written to be used, and may not 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. Legal Disclaimer This work is for discussion purposes only among legal and financial professionals. It is intended to provide general information about selected provisions of the American Taxpayer Relief Act. Neither the author, his firm nor anyone forwarding or reproducing any part of this work shall have any liability or 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. Each taxpayer is advised to, and should rely on, his or her own advisors. Credits In addition to provisions of the Internal Revenue Code (Title 26 of the United States Code), as amended by the American Taxpayer Relief Act of 2012 (H.R. 8 as passed by the Senate, approved by the House of Representatives and, on January 2, 2013, signed into law by the President), the presenter gives credit to the following sources of information: Fiscal Cliff Legislation and What It Means for Your Clients Presented January 4, 2013, by: Robert S. Keebler, CPA, MST, AEP (Distinguished) Keebler & Associates, LLP (www.keeblerandassociates.com) The Ultimate Estate Planner, Inc. (www.ultimateestateplanner.com) The American Taxpayer Relief Act of 2012: How the New Law Reshapes the Future of Estate Planning Presented January 8, 2013, by: Robert S. Keebler, CPA, MST, AEP (Distinguished) Stan Miller, Esq. Randy Gardner, JD, LLM, CPA, CFP WealthCounsel (www.wealthcounsel.com) The Advisors Forum (www.advisorsforum.com) Information about the presenter appears on Page 14 of this handout. Beyond the Fiscal Cliff Page 2 of 14

3 Presentation Outline I. Income Tax Changes, including AMT (See Rev. Proc ) A. Income Tax Brackets on Taxable Income: Rate/Bracket Married Joint & SSpouse Head of Household Single (except SS or HH) Married Separate Estates & Trusts* 10% 0 to 17,850 0 to 12,750 0 to 8,925 0 to 8,925 n/a 15% 17,851 to 12,751 to 8,926 to 8,926 to 0 to 2,450 72,500 48,600 36,250 36,250 25% 72,501 to 48,601 to 36,251 to 36,251 to 2,451 to 5, , ,450 87,850 73,200 28% 146,401 to 125,451 to 87,851 to 73,201 to 5,701 to 8, , , , ,525 33% 223,051 to 398, ,151 to 398, ,251 to 398, ,526 to 199,175 8,751 to 11,950 35% 398,351 to 398,351 to 398,351 to 199,176 to n/a 450, , , , % over 450,000 over 425,000 over 400,000 over 225,000 over 11,950 *Distributions from estates/trusts to beneficiaries can cause bracket shifts between them. Estates with fiscal years use 2012 rates. Estates with fiscal years or 2013 calendar year are subject to 2013 rates. B. Long Term Capital Gain and Qualified Dividend Rates for All* Taxpayers: If the Applicable Income Tax Bracket Is: 0-15% 0% 25-35% 15% 39.6% 20% The Tax Rate Is: *Distributions from estates/trusts to beneficiaries can cause bracket shifts between them. Estates with fiscal years use 2012 rates. Estates with fiscal years or 2013 calendar year are subject to 2013 rates. C. Alternative Minimum Tax Exemption Amounts for Taxpayers Other than Corporations. (See IRC 55) 1. Permanently indexed for inflation. (Note: AMT may not be significant for estates and trusts unless they include oil and gas investments.) 2. Exemption amounts of taxable income: Joint Returns or Surviving Spouses $78,750 for 2012; $80,800 for 2013 Unmarried Individuals (other than Surviving Spouses) $50,600 for 2012; $51,900 for 2013 Married Individuals Filing Separate Returns $39,375 for 2012; $40,400 for 2013 Estates and Trusts $22,500 for 2012; $23,100 for 2013 Beyond the Fiscal Cliff Page 3 of 14

4 3. Excess taxable incomes above which the 26% AMT rate ends and 28% applies: Joint Returns, Unmarried Individuals (other than surviving spouses), and Estates & Trusts $175,000 for 2012; $179,500 for 2013 Married Individuals Filing Separate Returns $87,500 for 2012; $89,750 for Amounts of taxable income used to determine the phase out* of exemption amounts: Joint Returns or Surviving Spouses $153,900 for 2013 (completed at $461,700) Unmarried Individuals (other than Surviving Spouses) Married Individuals Filing Separate Returns and Estates & Trusts $115,400 for 2013 (completed at $346,200) $76,950 for 2013 (completed at $230,850) *The exemption amount of any taxpayer will be reduced, but not below zero, by an amount equal to 25% of the amount by which the alternative minimum taxable income of the taxpayer exceeds these amounts. II. Phase Outs for Itemized Deductions and Personal Exemptions (See Rev. Proc ) A. Standard Deductions: Filing Status: Married Individuals Filing Joint Returns and Surviving Spouses Standard Deduction: $12,200 Heads of Households $8,950 Unmarried Individuals (other than Surviving Spouses and Heads of Households) $6,100 Married Individuals Filing Separate Returns $6,100 B. Phase Out Thresholds for Itemized Deductions and Personal Exemptions: Filing Status: Married Individuals Filing Joint Returns and Surviving Spouses Threshold (AGI): $300,000 (completed at $422,500) Heads of Households $275,000 (completed at $397,500) Unmarried Individuals (other than Surviving Spouses and Heads of Households) $250,000 (completed at $372,500) Married Individuals Filing Separate Returns $150,000 (completed at $211,250) C. Itemized Deductions Phase Out ( Pease Amendment ): Phase out rate is 3% of excess income, up to a maximum of 80% of deductions (i.e., result not less than 20% allowable). Deductions not included in Pease Beyond the Fiscal Cliff Page 4 of 14

5 III. 1. Investment interest expense. 2. Medical expenses. 3. Casualty, theft and wagering losses. D. Personal Exemption ($3,900) Phase Out (PEP): Phase out rate is 2% for 1. Every $2,500 of excess income for single taxpayers. 2. Every $1,250 of excess income for married taxpayers filing jointly. Medicare Surtax on Earnings and Investment Income A. Earnings: 0.9% surtax on payroll (no employer matching) and self-employment income in excess of 1. $200,000 for single taxpayers. 2. $250,000 for married taxpayers filing jointly and surviving spouses. 3. $125,000 for married taxpayers filing separately. Note: The payroll tax holiday expired. Employees tax reverts to 6.2% from 4.2%. B. Investment Income: 1. Personal returns: 3.8% surtax on the lesser of net investment income or MAGI (i.e., AGI plus adjustment for foreign earned income) in excess of a. $200,000 for single taxpayers. b. $250,000 for married taxpayers filing jointly and surviving spouses. c. $125,000 for married taxpayers filing separately. 2. Estate and trust returns: 3.8% surtax on the lesser of net investment income or AGI in excess of $11, Net Investment Income : a. Included i. Taxable interest. ii. Dividends. iii. Annuity distributions. iv. Rents. v. Passive royalties. vi. Passive activity income. vii. Net capital gains. b. Not included i. Salary, wages, bonuses, self-employment. ii. Distributions from IRAs and qualified plans. Beyond the Fiscal Cliff Page 5 of 14

6 IV. iii. Pensions. iv. Active royalties. v. Gain on sale of active interests in partnerships or S corporations. vi. Items otherwise excluded or exempt from income (e.g., interest from taxexempt bond, capital gain excluded under IRC 121, Social Security income, veteran benefits, etc.). IRA Direct Transfers to Charity (Qualified Charitable Distribution) A. Benefits: 1. Up to $100,000 per calendar year. 2. The QCD is not included in gross income; so AGI or MAGI amounts serving as thresholds or limitations are not raised. 3. The transfer can be applied to satisfy the Required Minimum Distribution amount. B. Requirements (subject to exceptions mentioned below in IV.C and IV.D): 1. IRA owner must be at least 70½ on the date of transfer. 2. Distribution must be to an eligible charity under IRC Distribution must be directly from the IRA custodian/trustee by check or wire payable in the name of the charity. 4. Distribution must have otherwise been includible in gross income. 5. Distribution cannot be taken as an itemized charitable contribution deduction. C. Any portion of a voluntary or required personal distribution during December 2012 can be treated as a QCD for 2012 if 1. The portion is transferred in cash to an eligible charity during January 2013; and 2. Except for the fact that the distribution was not transferred directly to a charity, the distribution meets all other QCD requirements. D. By election, any QCD made during January 2013 is deemed to have been made on December 31, 2012 (thus, no reduction in $100,000 available for 2013). V. Estate, Gift and Generation Skipping Transfer Taxes, including Portability A. ATRA retained the state death tax deduction without going back to a state death tax credit. All state death tax laws as of December 31, 2012, whether coupled or decoupled, remain unchanged by ATRA. B. Uniform exclusions and rates (made permanent ): 1. For 2013, $5,250,000 (inflation-adjusted) is the Applicable Exclusion Amount (new term, changed from lifetime exemption or basic exclusion amount). 2. The new exclusion amount avoided the potential claw back issue raised by the prospects of dropping to a lower amount in 2013 from a higher amount in Repealed the 5% surtax on estates over $10,000,000. Beyond the Fiscal Cliff Page 6 of 14

7 4. Tax Rate Schedule per IRC 2001(c): If the amount with respect to which the tentative tax to be computed is: The tentative tax (i.e., before credits) is: Not over $10,000 Over $10,000 but not over $20,000 Over $ but not over $ Over $20,000 but not over $40,000 Over $40,000 but not over $60,000 Over $60,000 but not over $80,000 Over $80,000 but not over $100,000 Over $100,000 but not over $150,000 Over $150,000 but not over $250,000 Over $250,000 but not over $500,000 Over $500,000 Over $500,000 but not over $750,000 Over $750,000 but not over $1,000,000 Over $1,000, percent of such amount $1,800, plus 20 percent of the excess of such amount over $10,000 $3 800 plus 22 percent of the excess of such amount over $ $3,800, plus 22 percent of the excess of such amount over $20,000 $8,200, plus 24 percent of the excess of such amount over $40,000 $13,000, plus 26 percent of the excess of such amount over $60,000 $18,200, plus 28 percent of the excess of such amount over $80,000 $23,800, plus 30 percent of the excess of such amount over $100,000 $38,800, plus 32 percent of the excess of such amount over $150,000 $70,800, plus 34 percent of the excess of such amount over $250,000 $155,800, plus 35 percent of the excess of such amount over $500,000 $155,800, plus 37 percent of the excess of such amount over $500,000 $248,300, plus 39 percent of the excess of such amount over $750,000 $345,800, plus 40 percent of the excess of such amount over $1,000, Applicable Exclusion Amount of $5,250,000 means 2013 estate tax credit of $2,045,800. Calculation: [(5,250,000-1,000,000) x 40%] + 345,800 = 2,045,800. C. Portability (Deceased Spousal Unused Exclusion Amount) made permanent for decedents dying after December 31, 2010: 1. Special election must have been made and information entered on Form 706 by the predeceased spouse s estate, even if there was no estate tax liability. 2. Applies only to estate and gift tax relative to the last deceased spouse s applicable exclusion amount. 3. Does not apply to GST tax. a. For multi-generational planning, there is typically not much, if any, reliance on portability to avoid estate tax or achieve step-up in basis. b. For GST planning, fully funding the Credit Shelter Trust is still advisable. Beyond the Fiscal Cliff Page 7 of 14

8 VI. Tax Strategies for Estates under $5.25 million ($10.5 million for portable couples) A. Should continue with non-tax strategies for legacy considerations surrounding any transfer of wealth, asset protection, elder care issues, etc. B. Credit Shelter Trusts (still viable): 1. For multi-generational (dynasty) planning to the extent allowed by state law. 2. Trust Protector provisions can allow surgical granting of powers of appointment to achieve desirable step-ups in basis, which can avoid the need for a marital deduction trust, especially one that would include remarriage restrictions on distributions of principal. 3. To protect against a beneficiary s getting pushed over the applicable exclusion because of personal wealth accumulation or inheritance outside of the CST. 4. To leverage trust assets for surviving beneficiaries, whether or not multi-generational, by purchasing and owning life insurance as an alternative trust investment. C. Grantor trusts still avoid estate tax, including Intentionally Defective Grantor Trusts. D. Irrevocable Life Insurance Trusts (ILITs), whether grantor or not: 1. Life insurance growth and payouts are income tax exempt. 2. Loans and withdrawals are income tax free. E. Non-trust life insurance policies: 1. Growth and payouts are income tax exempt. 2. Loans and withdrawals are income tax free. F. Beneficiary Defective Inheritor s Trusts (BDITs), when inheritance may push the client over the applicable exclusion. G. Alaska Community Property Trust provisions (inside of a joint pour-over trust): 1. Clients in separate property states can get step-up in basis at first death. 2. Survivor can diversify assets without the capital gain which may have resulted without the step-up H. Family Limited Partnerships, and even family LLCs: 1. Not so much for estate tax purposes but for income allocation purposes (more like in the old days ); but beware the kiddie tax. 2. Must meet requirements of IRC 704(e) and Treas. Reg (e). 3. Upon death, can consider election under IRC 754 to step-up basis. I. Spousal Lifetime Access Trusts (SLATs) may be preferable to Bypass Trusts, especially for clients in a decoupled state with low exemption. Beyond the Fiscal Cliff Page 8 of 14

9 J. Others Ideas K. Lowering/Deferring Income Tax: 1. Depending upon liquidity needs, consider selling income generating assets (e.g., bonds, stocks) to reduce mortgage debt if deductibility of mortgage interest is subject to the Pease phase out. 2. Consider participation in defined benefit plans as part of compensation package, instead of relying on currently taxable earned income. 3. Before recommending between non-grantor trusts and grantor trusts, run calculations carefully, accounting for cumulative, total taxation on each respective set of federal and state income tax returns, as applicable a. Income tax bracket, plus b. AMT, plus c. Pease phase out, plus d. PEP phase out, plus e. 0.9% surtax, plus f. 3.8% surtax. 4. Charitable Remainder Trusts: a. Assets can be contributed and, within limits, a current charitable deduction obtained. b. Income and capital gains within the trust are not taxable (because of its tax exempt status) unless and until distribution is made to a non-charitable beneficiary (typically the client or client s family during the term of the trust). c. When distributed to a non-charitable beneficiary, the distributions are characterized based on the history of what would have been taxed to the trust, but for its exempt status. d. Distributions can be deferred until a time when the non-charitable beneficiary is in a reduced income tax bracket or has moved from a state with high state income tax to a state with lower or no state income tax. 5. Charitable Lead Trusts: Income does not affect the grantor s personal return. 6. Managing clients fears about income taxes: Who really gets hit the hardest? And by how much? Beyond the Fiscal Cliff Page 9 of 14

10 $170,341 $14,812 Average tax increase by income level $68 $1533 $297 $445 $579 $822 $1,206 $1,784 $2,711 LESS THAN $10,000 $10K $20K $20K $30K $30K $40K $40K $50K $50K $75K $75K $100K $100K $200K $200K $500K $500K $1 MILLION MORE THAN $1 MILLION Percentage-point change from 2012 Source: Tax Policy Center, TIME, January 14, 2013 VII. Tax Strategies for Estates over $5.25 million ($10.5 million for portable couples) A. Strategies for estates under $5.25 million ($10.5 million for portable couples) also work at this level, including traditional, annual-exclusion gifts. B. FLPs/LLCs valuation discounts are still allowed. C. Two-year rolling GRATs (Grantor Retained Annuity Trusts) are still allowed. D. Intentionally Defective Grantor Trusts (IDGTs) are still allowed. E. Sales to Grantor Trusts with Self-Canceling Installment Notes (SCINs) and Private Annuities are still allowed. F. Can consider moving residence from a jurisdiction with unfavorable state tax laws to one with more favorable laws. G. For businesses that can satisfy applicable sourcing rules, can consider moving income offshore to Virgin Islands (90% reduction) or Puerto Rico (100% reduction). Beyond the Fiscal Cliff Page 10 of 14

11 H. Others Ideas VIII. Some Extensions Regarding Businesses and Real Estate A. Two-year, retroactive extension to include 2012 and 2013 for the favorable deductibility rule for charitable gifts made by S corporations. 1. Without ATRA, the rule would have applied only to tax years 2006 through See IRC 1367(a)(2) and Thomson Reuters RIA Federal Tax Handbook The rule a. The decrease in a shareholder s basis in S corporation stock by reason of a charitable contribution made by the S corporation equals the shareholder s pro rata share of the adjusted basis of the contributed property. b. Where this rule applies to limit the decrease in the basis resulting from the contribution, the rule that limits the aggregate amount of losses and deductions that may be taken by the S corporation shareholder to the shareholder s basis in the S corporation s stock and debt does not apply to the extent of the excess (if any) of i. The shareholder s pro rata share of the charitable contribution, over ii. The shareholder s pro rata share of the adjusted basis of such property. B. Business Asset Cost Recovery: 1. Can suggest using cost segregation studies/strategies. 2. Extends additional first-year 50% bonus depreciation for certain new property purchased and place in service before January 1, 2014 (before January 1, 2015, for certain longer-lived property). 3. Section 179 annual depreciation expense amount is $500,000 for taxable years beginning in 2012 and (Phase out level begins at $2,000,000 in annual purchases.) And see below, VIII.C, Real Estate Cost Recovery. C. Real Estate Cost Recovery: 1. Section 179 annual depreciation expense amount of $500,000 can include up to $250,000 of qualified leasehold improvements, qualified restaurant property, and qualified retail improvements. 2. Extends 15-year straight-line (instead of 39-year) cost recovery through 2013 for qualified leasehold improvements, qualified restaurant property, and qualified retail improvements. D. S corporation built-in gains tax: 1. Holding period reduced from 10 years to 5 years for sales occurring in 2012 and Beyond the Fiscal Cliff Page 11 of 14

12 IX. 2. May lead to conversions from C status to S status, especially if income is low but value is high. E. Extends through 2013 the special rule for contributions of capital gain real property made for conservation purposes (i.e., contribution can be taken against 50% of the contribution base), as well as for contributions by certain corporate farmers and ranchers. F. Qualified Small Business Stock (QSBS): Extends exclusion for capital gain from sale of QSBS acquired after September 27, 2010, and before January 1, 2014, if the stock is owned longer than five years. 1. AMT preference rules would not apply. 2. Exclusion does not apply to law firms or other service type businesses, only retail, manufacturing, brick & mortar types of businesses. G. There are other extensions, but not of so much of concern to estate planning professionals as to business attorneys and accountants. Some Extensions Regarding Education Plans A. Extends through December 31, 2017, the American Opportunity Tax Credit (AOTC is an enhanced, but temporary, version of the permanent HOPE education tax credit) up to $2,500 per year, subject to phase out 1. For single filers with a modified adjusted gross income (MAGI) of more than $80, For joint filers with a MAGI of more than $160,000. B. Permanent extensions: 1. Qualified tuition deductions ( above the line in lieu of higher education credits) extended through 2013, retroactively to a. $4,000 available for MAGI up to $65,000 for single filers and $130,000 for joint filers. b. $2,000 available for a MAGI up to $80,000 for single filers and $160,000 for joint filers. 2. Coverdell Education Savings Accounts (ESAs) funding up to $2,000 annually (rather than $500). ESAs allow expenditures for elementary and secondary education in addition to post-secondary education. 3. Educational assistance exclusion of $5,250 X. Retirement Plan Conversions A. Direct conversions (taxable) from a 401(k), Thrift Savings Plan, 403(b) or 457(b) account to a Roth account are allowed beginning in B. Previously, participants could only take distributions of right (e.g., over 59½ or separated from service). C. The Pease deductions phase out may diminish the sheltering of conversion income. D. Cannot re-characterize a conversion from a 401(k), etc., like from an IRA. Beyond the Fiscal Cliff Page 12 of 14

13 XI. Iceberg Beyond the Fiscal Cliff Page 13 of 14

14 XII. About Mitchiner Joseph H. Mitchiner, Attorney The work of Mitchiner Law Firm, PLLC, is exclusively limited to Wills, Trusts and Estate Planning, including related aspects of taxation, business organization and asset protection. A bonus is that Joe Mitchiner has been licensed and engaged in the private practice of law in North Carolina since 1977, with extensive experience in real estate, construction law and civil litigation matters. Joe received his college degree in business administration and his law degree with magna cum laude honors. He has been blessed with a long marriage and twin children, also married. Law practice history: Private practice since 1977 with years of concentration in estate and income taxes, Wills, probate administration, real estate matters, construction law and civil litigation. Practice now limited exclusively to Wills, Trusts and Estate Planning, including related aspects of taxation, business organization and asset protection. Personal and professional history: Born in Smithfield, NC, June 10, 1951; resident of Raleigh, NC, since 1956; son of J. Elton Mitchiner, Tax Attorney ( ) Admitted to the North Carolina Bar in 1977 and the Florida Bar in 1978 Admitted to practice before the following federal courts: Education: U.S. Supreme Court U.S. Court of Appeals for the Fourth and Eleventh Circuits U.S. Tax Court U.S. District Courts for the Eastern and Middle Districts of North Carolina U.S. District Court for the Southern District of Florida University of North Carolina at Chapel Hill (Bachelor of Science in Business Administration, 1973) North Carolina Central University School of Law (Juris Doctorate, magna cum laude, 1976) Professional Associations: NC Bar Association-Estate Planning & Fiduciary Law Section; Wake County Bar Association; Wake County Estate Planning Council; WealthCounsel (a national collaboration of estate planning attorneys); Kingdom Advisors (a ministry of biblically principled financial professionals); Christian Legal Society You are invited to visit our Web Site for additional, hopefully helpful, generally educational information. Beyond the Fiscal Cliff Page 14 of 14 LAW FIRM, PLLC

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