A look at some of the planning you can accomplish now that the American Taxpayer Relief Act of 2012 and the Medicare surtax are in effect

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1 FROM THE J.P. MORGAN ADVICE LAB in your interest STRATEGIES TO CONSIDER IN LIGHT OF NEW TAX LAW A look at some of the planning you can accomplish now that the American Taxpayer Relief Act of 2012 and the Medicare surtax are in effect After much uncertainty, the President has signed the American Taxpayer Relief Act of 2012, which raises taxes for high income earners and trusts, but allows taxpayers to implement income tax, gift and estate planning with a reasonable degree of confidence. In this edition of in your interest, we discuss a host of new tax provisions that may impact U.S. taxpayers and create opportunities to take advantage of six key planning strategies. (See Strategies to consider in 2013, on page 5.) THE NEW TAX LAW KEY PROVISIONS OF THE AMERICAN TAXPAYER RELIEF ACT OF 2012 Individuals may be most impacted by the provisions of the American Taxpayer Relief Act of 2012 that permanently: Extend income tax relief for taxpayers with taxable income below $400,000 (single) or $450,000 (joint). For income above these levels, the top marginal tax rate will return to 39.6%. As anticipated, these income thresholds are higher than the $200,000/$250,000 originally proposed by the President, but lower than the $1 million proposed by a number of legislators. Raise the top long-term capital gain (LTCG) and qualified dividend rates to 20%. Capital gain and dividend rates are now 20% for taxpayers above the $400,000/$450,000 income thresholds. However, when an individual s taxable income (excluding capital gains and dividends) is less than the threshold, the portion of those capital gains and dividends below the threshold is still taxed at a 15% rate; any portion above the threshold is to be taxed at 20%. Qualified dividends will continue to be taxed at LTCG rates. Also, a new 3.8% Medicare surtax applies to both capital gains and dividends above a $200,000/$250,000 modified adjusted gross income threshold. Therefore, capital gains CHANGES FOR HIGH-NET-WORTH FAMILIES Both the American Taxpayer Relief Act and the Medicare surtax alter the tax landscape TOP U.S. TAX RATE CHANGES JANUARY 1, 2013 Earned income tax Unearned income tax Capital gains tax Qualified dividend tax Estate & gift tax Estate & gift tax exemption Relative change 36.45%* 41.95%* = 15.09% 35.00% 43.40%** 24.00% = 15.00% 23.80%** = 58.67% 15.00% 23.80%** = 58.67% 35.00% 40.00% = 14.29% $5,120,000 $5,250,000 = 2.54% *Includes Medicare tax on earned income (1.45% in 2012, 2.35% in 2013). **Includes new 3.8% Medicare tax on unearned income. Sources: J.P. Morgan, IRS in your interest is a series of timely alerts sent by J.P. Morgan representatives to inform and update. JPMorgan Chase & Co. and its subsidiaries do not render accounting, legal or tax advice. Estate planning requires legal assistance. You should consult with your independent advisors concerning such matters. The views and strategies described herein may not be suitable for all investors. This information is not intended as an offer or solicitation for the purchase or sale of any financial instrument.

2 2 in your interest and dividends may be subject to a top effective rate of 23.8%. (See New Medicare taxes, on page 3.) Restore the personal exemption phase-out (PEP). The personal exemption phase-out is restored for taxpayers with adjusted gross incomes (AGIs) higher than $250,000 (single) or $300,000 (joint). This means high-income taxpayers may lose the benefit of their $3,900 personal exemption for themselves and any dependents. Restore the Pease limitations. The Pease limitations on itemized deductions that existed in prior law are restored for taxpayers with AGIs higher than $250,000 (single) or $300,000 (joint). For these taxpayers, this limitation reduces allowable itemized deductions by 3% of AGI exceeding the $250,000/$300,000 thresholds, but no more than 80% of the total deductions. These limits primarily affect deductions for state taxes, mortgage interest and charitable contributions. For most high-income taxpayers, this provision effectively results in a tax increase of roughly 1.2%. Despite much discussion, the Act did not impose any new limitations targeted at key itemized deductions, such as the mortgage interest and charitable deductions. For the vast majority of taxpayers, especially those in high-tax states, the Pease limitations should have no effect on decisions about whether to make charitable contributions, as the 3% reduction will be fully absorbed by their state income tax and other deductions. Index the Alternative Minimum Tax (AMT) exemption to inflation. Before this legislation, lawmakers periodically had to patch a higher exemption amount to avoid subjecting millions of additional taxpayers to the AMT. The patch is now permanent. Going forward, the AMT exemption and the threshold for that exemption phase-out will be indexed to inflation. This provision applies to 2012, as well. Set federal estate/gift/generation-skipping transfer (GST) tax rates at 40%. Significantly lower than the 55% rate that had been set to go into effect on January 1, 2013, the new maximum rate for all three taxes splits the difference between last year s 35% rate and 2009 s 45% rate. It also ensures that top transfer tax rates remain above top income tax rates. Set federal estate/gift/gst tax exemptions at $5 million, adjusted for inflation. These exemptions are indexed for inflation. The 2013 inflation-indexed exemption amount is $5.25 million, which is $130,000 higher than last year s $5.12 million. The inflation-adjustment provision may offer significant additional gifting opportunities over time. Extend portability of unused transfer tax exemptions. Portability allows surviving spouses (of couples considered to be married under federal law) to continue to use their deceased spouses unused gift and estate tax exemptions, if certain estate tax informational filing requirements are met. This provision ensures that a couple s total gift WHAT IS YOUR NEW TAX RATE? The 2013 tax rates, based on filing position and level of income Single Married filing jointly* Head of household * Brackets for married taxpayers filing separately are one half those listed for married filing jointly. Non-grantor trusts & estates Tax rate $0 8,925 $0 17,850 $0 12,750 10% $8,925 36,250 $17,850 72,500 $12,750 48,600 $0 2,450 15% $36,250 87,850 $72, ,400 $48, ,450 $2,450 5,700 25% $87, ,250 $146, ,050 $125, ,150 $5,700 8,750 28% $183, ,350 $223, ,350 $203, ,350 $8,750 11,950 33% $398, ,000 $398, ,000 $398, ,000 35% $400,000+ $450,000+ $425,000+ $11, %

3 in your interest 3 and estate tax exemption will effectively be $10 million (plus inflation adjustments). The GST exemption is not portable. It is still worthwhile for taxpayers to consider using their lifetime exemptions. Extend the deduction for state death taxes. The Act replaced the scheduled estate tax credit with a deduction for state estate taxes paid. Thus, effective estate tax rates may vary by state. For example, the effective estate tax rate (federal and state) for New York is 49.6%; for Connecticut, 47.2%; and for both California and Texas, 40%. Restore the full payroll tax rate. The Act allowed the 2% cut in payroll and self-employment taxes to expire. On January 1, 2013, the tax reverted to 6.2%, applicable in 2013 to the first $113,700 of compensation. Allow in-plan Roth conversions. This provision was included in the Act as a revenue raiser. It expands the in-plan Roth rollover provisions to permit vested, otherwise undistributable amounts (e.g., 401(k) deferrals, employer matching or non-elective contributions, or earnings) from 401(k), 403(b) or 457(b) plans to be transferred to designated Roth accounts in the same plan. The conversion is now possible only if plan documents provide for it. Previously, participants could make Roth conversions only for amounts they could withdraw from the plan upon reaching age 59½ or separating from service. Reinstate regulated investment company (RIC) qualified entity treatment under the Foreign Investment in Real Property Tax Act (FIRPTA). This provision, reinstated for 2012 and 2013, allows non-resident aliens who are invested in U.S.-controlled mutual funds and most exchange-traded funds (taxed as mutual funds) that hold substantial U.S. real property interests to receive more favorable tax treatment. The FIRPTA tax will not be applied on capital gains when those interests are sold. Exempt RIC interest-related dividends paid to foreigners from withholding. Extended through 2013 are certain temporary provisions under which mutual funds can categorize interest-related dividends paid to non-u.s. persons as exempt from a 30% withholding tax. NEW MEDICARE TAXES The U.S. Supreme Court s decision last year to uphold the Patient Protection and Affordable Care Act means new Medicare taxes are in effect starting in 2013 for high-income taxpayers. High-income taxpayers are defined as single filers with AGIs over $200,000 or joint filers with AGIs exceeding $250,000. Earned income in excess of these thresholds will be subject to 90 basis points of additional Medicare tax over the 1.45% rate imposed on all earned income. This means that individual taxpayers will owe 2.35% of tax on earned income above the thresholds. ADDING THE NEW MEDICARE TAX A quick look at the impact of the Medicare surtax on top federal rates Top federal tax Medicare tax Total Top federal tax increase Medicare surtax Total Earned income 35.00% 1.45% 36.45% 4.60% 0.90% 41.95% Capital gains 15.00% 0.00% 15.00% 5.00% 3.80% 23.80% Dividends 15.00% 0.00% 15.00% 5.00% 3.80% 23.80% Interest 35.00% 0.00% 35.00% 4.60% 3.80% 43.40%

4 4 in your interest Unearned income will be subject to a 3.8% tax levied on the lesser of net investment income or modified AGI in excess of these thresholds. 1 The tax does not apply to qualified retirement plan and IRA distributions nor to taxexempt bonds. Trusts and estates will be subject to a 3.8% tax on unearned income on the lesser of undistributed net investment income or AGI over the threshold at which the highest trust and estate bracket begins ($11,950 in 2013). The tax does not apply to non resident aliens or fully charitable trusts. Note that while this tax is not imposed on charitable remainder trusts, it is applicable to some or all of the distributions from such trusts to income beneficiaries. IMPACT ON TRUSTS AND ESTATES Under the American Taxpayer Relief Act of 2012, for nongrantor irrevocable trusts or estates with undistributed net income, the top 39.6% income tax rate generally applies to all fiduciary income over this year s threshold of $11,950. In 2013, brackets for estates and for trusts jump from 33% for income between $8,750 and $11,950 to 39.6% for income above $11,950. (No fiduciary income is taxed at 35%.) While the new 3.8% Medicare surtax applies to both trusts and estates, the Pease limitations on itemized deductions will not apply to fiduciary income. (See Trusts and estates, above.) Note: Trustees may want to consider distributing discretionary taxable income to trust beneficiaries who are in lower income tax brackets and can absorb more income before being subject to top income tax rates and Medicare surtax. That is because (1) the highest income tax bracket for trusts and estates starts at $11,950, which is also the threshold that triggers the 3.8% Medicare tax; and (2) the trust threshold is lower than the individual thresholds applicable to both top income tax and Medicare surtax rates. NOT ADDRESSED The American Taxpayer Relief Act of 2012 does not address various proposals seeking to restrict the use of grantor retained annuity trusts (GRATs), grantor trusts, valuation discounts and dynasty trusts. It also does not include proposals to tax carried interest as ordinary income. These potential revenue-raising proposals may be revisited in the upcoming months during discussions over the federal debt ceiling and deficit reduction. HOW MUCH MORE MIGHT YOU PAY? A look at the 2012 and 2013 tax bills of three hypothetical taxpayers who have different sources, and levels, of income Scenario Wages $400,000 $400,000 Interest income $50,000 $50,000 Qualified dividends $25,000 $25,000 Net long-term capital gain $25,000 $25,000 Federal + payroll taxes $125,374 $132,066 Decrease in after tax income 1.8% Scenario 2 Wages $800,000 $800,000 Interest income $100,000 $100,000 Qualified dividends $50,000 $50,000 Net long-term capital gain $50,000 $50,000 Federal + payroll taxes $262,924 $304,161 Decrease in after tax income 5.6% Scenario 3 Wages $4,000,000 $4,000,000 Interest income $1,000,000 $1,000,000 Qualified dividends $1,000,000 $1,000,000 Net long-term capital gain $4,000,000 $4,000,000 Federal + payroll taxes $2,190,444 $2,989,521 Decrease in after tax income 10.2% Assumptions: Married filing jointly taxpayer with two children, assumes all wages are earned by one spouse. Calculations use actual tax brackets for year specified (including inflation adjustments, when applicable). The following deductions are assumed: state income taxes of 7% (flat); $20,000 property taxes; $40,000 home mortgage interest; charitable contribution equal to 2% of AGI. Four personal exemptions are assumed (prior to phase out in 2013). Tax calculations include: ordinary income tax; capital gains tax; qualified dividend tax; Pease limitation; personal exemption phase out; payroll taxes (Social Security and Medicare); Medicare surcharge and the Alternative Minimum Tax. 1 Net investment income includes interest, dividends, royalties, rental income, gross income from passive activities, businesses trading in financial instruments or commodities and net gain from disposition of non-business or passive activity property reduced by deductions connected to that income. Modified AGI is AGI plus the amount excluded from income as foreign earned income, net of certain disallowed deductions and exclusions.

5 in your interest 5 STRATEGIES TO CONSIDER IN CONSIDER CONVERTING YOUR TRADITIONAL RETIREMENT ACCOUNTS TO ROTH IRAS If you have a long time horizon, it can be beneficial to convert your traditional retirement accounts to Roth IRAs. IRAs It may make sense to accelerate income recognition through Roth conversions. Previous rules on Roth IRA conversions, which limited this opportunity to taxpayers earning less than $100,000, are no longer in effect, allowing all taxpayers to make these IRA conversions. Although your taxable income payable on converting to a Roth will be taxed at the higher 2013 rates, the tax-free compounding benefits will become more powerful than they were previously. Three questions are worth contemplating when thinking about a Roth conversion: 1. Will you have to pay the tax cost of conversion by using money withdrawn from your traditional IRA? 2. Do you think you will need any distributions from your IRA, whether Roth or traditional, to fund your retirement? 3. Are you planning to bequeath assets in your traditional IRA to charity? If you answer no to all three questions, a Roth conversion may be especially useful. Other retirement plans A new provision in the American Taxpayer Relief Act of 2012 allows in-plan Roth conversions with money in 401(k), 403(b) or 457(b) plans that is not otherwise distributable (e.g., 401(k) deferrals, employer matching or non-elective contributions, and earnings). Such conversions would result in taxable income in the year of conversion. Previously, plans could allow participants to convert their pre-tax accounts to Roth accounts but only with funds they had a right to withdraw from the plan, usually because they had reached age 59½ or separated from service. 2. CONSIDER INVESTMENT STRATEGIES THAT ARE TAX ADVANTAGED While taxes should not be the sole driver of investment decisions, investors should be tax aware. Strategies that may add value in a high-tax environment include: Municipal bonds. Tax-exempt bonds are potentially more attractive now because the effective interest rate (taxable equivalent yield) of municipal bonds generally increases as your federal and state income taxes rise. TIME-SENSITIVE OPPORTUNITY FOR CHARITABLE IRA ROLLOVERS The American Taxpayer Relief Act of 2012 restores and extends for two years (2012 and 2013) a provision that allows direct rollovers of up to $100,000 per taxpayer, per year, from IRAs to qualified charities (not including private foundations and donor advised funds). Such rollovers allow taxpayers to fulfill both their required minimum distribution requirements and charitable intentions without generating any taxable income. Because this provision is effective retroactively from December 31, 2011, to December 31, 2013, the Act includes two special relief provisions available only to taxpayers over the age of 70½ that expire on January 31, 2013: 1. Individuals making a qualified direct distribution in January 2013 are permitted to deem the distribution as though it had been made on December 31, Individuals who took an IRA distribution in December of 2012 can contribute that amount in cash to a qualified charitable organization before February 1, 2013, and have it count as an eligible charitable rollover in 2012 if it otherwise meets applicable requirements. These charitable distributions are not considered charitable deductions. As a result, they are not subject to the Pease limitations in 2013.

6 6 in your interest Annuities and life insurance policies. These vehicles allow you to defer income tax and generate more cash buildup. Charitable remainder trusts (CRTs). Particularly useful for appreciated assets in a high-tax environment, CRTs allow deferral of the capital gains tax due on a sale of trust assets. Pre-paid variable forwards. This structure allows a stock owner to effectively diversify a concentrated position without a current tax event. You can receive an upfront cash payment in exchange for delivering a variable amount of shares or cash at some specified time in the future, effectively deferring capital gains tax realization until the shares either are delivered to settle the contract or the contract is settled in cash. 3. MAXIMIZE THE IMPACT OF YOUR TAX DEDUCTIONS Charitable donations The Pease limitations on itemized deductions were reinstated such that itemized deductions are reduced by the lesser of 3% of AGI over the applicable threshold ($250,000 single/$300,000 joint) or 80% of the deductions. For taxpayers in high-income tax states, the 3% limitation effectively results in an additional 1.2% tax increase. USING ANNUITIES TO HELP COPE WITH HIGHER TAXES Increasing tax rates may make it more attractive to use tax-efficient vehicles for long-term investment pools whose assets generate ordinary income and short-term capital gains. Such vehicles include: Variable universal life policies Variable annuities These vehicles defer (in some cases, permanently) the recognition of earnings and gains for income tax purposes, allowing the value of the assets to compound tax free and providing significantly more value over time, after the extra costs of these vehicles are taken into account. Such benefits are even greater with higher taxes and higher investment returns. Assets that produce less tax-efficient returns (such as hedge funds), and which have longer holding periods, also can increase the benefits of annuities. J.P. Morgan estimates that in higher-tax environments, the additional investment benefit generated by a variable annuity could possibly exceed 100 basis points per year. ANNUITIES ARE MORE APPEALING NOW Income tax deferral is made more desirable by higher top marginal income tax rates and the Pease limitations on itemized deductions Illustrative example NYC resident with a balanced portfolio, current tax rates and modestly tax-inefficient vehicle Modestly lower benefits in jurisdictions with no state tax (TX, FL, WA, etc.) Pre-tax return Top marginal federal and state tax rate* % taxed at short-term gains, ordinary income % taxed at long-term gains Annual annuity benefit 8.0% 52.3% 70% 30% 167 bps 8.0% 43.4% 70% 30% 102 bps Higher returns offer increasing benefits 11.0% 52.3% 70% 30% 303 bps as do portfolios with less tax efficiency 11.0% 52.3% 100% 0% 481 bps Lower return, less tax-inefficient investments generate fewer benefits 5.0% 52.3% 50% 50% 47 bps Annuity benefit based on 20 year holding period, investment management fees of 1.5%, annuity fees of 55 basis points, and limited deductibility of state/ local taxes and management fees due to AGI limitations. Assumes New York City income tax is 12.7%; Florida, Texas and Washington have no state income tax. * Includes 39.6% top marginal rate, 3.8% Medicare surtax on unearned income, applicable state income tax and adjusts for deductibility and the Pease limitation where applicable. J.P. Morgan is not a licensed insurance provider. J.P. Morgan does not offer insurance advice, including the selection of insurance products, insurance brokers or insurance carriers. Please consult an insurance broker of your choice regarding your situation.

7 in your interest 7 However, deductibility of charitable donations should not be impacted for taxpayers in these states because the limitation is usually absorbed by the state tax deduction. Therefore, charitable donations should still provide a deduction that is equal to the top tax rate of 39.6%. When the 80% limitation applies to a taxpayer, the deductible value of the charitable contribution may be affected. Investment interest expenses The reinstatement of the Pease provisions may limit deductibility for investment-related expenses, including investment management fees. Certain vehicles that would not render investment expenses subject to Pease limitations include: Regulated investment companies (RICs)/real estate investment trusts (REITs)/exchange-traded funds (ETFs). Mutual funds, REITs and ETFs generally employ tax accounting that results in investment-related expenses, including management fees, being taken directly against income before reporting on Form 1099 on a net-ofexpense basis. Passive foreign investment companies (PFICs). If the PFIC provides a taxpayer with the information required to allow the taxpayer to make a qualified electing fund (QEF) election, then the PFIC tax accounting conventions deduct investmentrelated expenses directly against gross realized income in determining a U.S. investor s reportable taxable income. Although subject to additional tax information disclosures, this alternative may be particularly advantageous for investments that otherwise produce ordinary income for tax purposes, as net reportable PFIC income is characterized as net ordinary income and/or net capital gain. Variable annuities. Annuity tax accounting conventions directly reduce earnings by all investment-related expenses before issuing a Form 1099 on net lump sum or regular annuity distributions. Similar tax accounting rules may apply to certain life insurance distributions. Trading accounts. For trading accounts, trading commissions reduce gains or increase losses on 1099-B as opposed to being structured as discrete investment management fees. USE TAX DEFERRED COMPENSATION ELECTIONS TO YOUR ADVANTAGE Unless you must take your income now, it is generally economical to defer, and these benefits increase as tax rates rise. Generally, the longer you are able to delay paying taxes on income and investment returns, the more value there will be to compound. Assuming constant tax rates until the year of distribution, the federal rate would have to increase dramatically in the year of distribution to justify not deferring. Decisions should be made on both: New income on which you are making the initial decision to defer Distributions from accounts holding income that you already have deferred However, any decision must take into account: Exposure Deferring income into plans (such as deferred compensation plans) will make you a general unsecured creditor of a company. Liquidity It is essential to carefully consider your liquidity needs, as deferral plans may limit access to deferred income. Additional factors Length of time you plan to defer Timing and size of any future tax rate changes Returns that can be earned inside versus outside the deferral plan WHEN DOES IT MAKE SENSE TO DEFER? Higher taxes and longer horizons increase the benefit of deferring income After-tax value of $1MM Higher taxes increase the benefit of deferral $MM $4.5 $4.0 $3.5 Defer $3.0 Don't defer $2.5 $2.0 $1.5 $1.0 $0.5 $ Years Assumptions: $1 million pre-tax starting value; 8% pre-tax return, of which 2% is yield and 6% appreciation; 40% annual turnover; 43.4% income tax and 23.8% capital gains tax.

8 8 in your interest 4. TAKE ADVANTAGE OF GIFT PLANNING TO INCREASE WEALTH FOR YOUR FAMILY The gift tax exemption, set at $5.25 million in 2013, is now permanent. The new law sets the lifetime gift tax exemption at $5 million, adjusted annually for inflation. This year s $5.25 million is the highest level ever, providing the opportunity to transfer substantial amounts to heirs free of transfer taxes. It is a fundamental tenet of good estate planning to use exemptions early, because once assets are gifted, future income and growth are not taxed at death. The exemption can be used either for outright gifts or for transfers to trusts, including generation-skipping trusts. To make the most of your exemptions, consider: Giving assets that have strong return potential Transferring assets that can be discounted for gift tax purposes Giving to irrevocable grantor trusts, so that the grantor can pay the ongoing income tax liabilities on trust investments, maximizing the return to heirs Giving assets with higher cost basis (when possible), since the donor s basis carries over to the donees Forgiving loans previously made to heirs It is also important to keep in mind the impact that making a gift might have on your lifestyle and spending needs. If you decide to gift, consider the following strategies that allow for a tax-efficient transfer of assets. Federal lawmakers have discussed proposals that would restrict some of these approaches. It may, therefore, be worthwhile for taxpayers to act quickly to take advantage of them now, in case Congress revisits the strategies during this year s budget deliberations. Full use of gift tax exemption. If you used your exemption in 2012, you have another $130,000 to consider gifting tax free this year due to the 2013 inflation adjustments. Grantor trust. Gifts to an irrevocable grantor trust allow you, as the grantor, to pay the income tax liabilities generated by trust investments out of your taxable estate. This effectively shifts the income tax burden away from your family s assets to a pool of funds that eventually will otherwise be subject to estate tax. By paying the trust s income taxes, you are TRUSTS OFFER UNIQUE ADVANTAGES When making gifts, an important consideration is whether you want your donee to have immediate access to funds. Wealthy individuals have long recognized the advantages of transferring assets in trust: Trusts allow you to limit heirs access to principal and income before they are ready. You can specify the timing, amounts and conditions of distributions to heirs, or give discretion to your trustees to make distribution decisions consistent with your wishes. Trusts facilitate asset management through your selection of highly skilled trustees and investment advisors with requisite skills to manage enduring portfolios that allow for consistent, long-term compounding of investment returns. The investment strategy for your trust should be designed to minimize risk and protect your valuable gift exemption. Trustee meetings in which family members participate provide education on financial markets and prudent investment principles. They allow children to understand and monitor investment plans. Trusts may provide asset protection, putting your gift beyond the reach of your children s or grandchildren s creditors or ex-spouses. Why a Delaware trust? Consider the most appropriate location for your trust. Delaware is a jurisdiction of choice for wealthy individuals around the world because it offers a favorable and flexible trust environment through its laws and Court of Chancery. Depending on your circumstances, Delaware trusts may offer favorable income tax treatment for trusts established by residents of other states. Delaware trusts may offer enhanced creditor protection, greater privacy about the existence of the trust, and also allow trusts to be extended in perpetuity, a great advantage to those seeking to benefit multiple generations. Delaware trusts may be subject to income tax by the states of residence and domicile of the trust creator, trustee and beneficiaries of the trust. Creditors may be able to reach assets under certain circumstances, including claims resulting from alimony and child support.

9 in your interest 9 essentially making a tax-free gift to heirs. Meanwhile, the trust assets can grow income tax free, preserving more value for the family in the long term. Dynasty trust. The $5.25 million GST tax exemption in 2013 is the highest ever, creating a tremendous opportunity to fund trusts whose future distributions to grandchildren and subsequent generations will be free of GST taxes. Keep in mind that GST exemptions are not portable, so a surviving spouse cannot make use of the exemption a decedent failed to use. Therefore, both spouses should affirmatively plan to use this exemption either during life or at death. A note for U.S. individuals who expect to inherit foreign assets from foreign persons: A dynasty trust created by a foreign grantor and funded with foreign assets is not subject to these limitations. This means significantly higher value assets can pass into a foreign grantor trust free of U.S. estate, gift or GST taxes. Such trusts can be structured to be revocable during the grantor s life, so any distribution to the U.S. beneficiaries during the grantor s lifetime would be treated as a tax-free gift. Sale to an irrevocable grantor trust. After using your lifetime gift exemption (and potentially your GST tax exemption) to fund an irrevocable grantor trust, you can consider making an arm s-length sale of assets to the trust in a tax-free exchange for an interest-bearing note. Such a sale will magnify the gift s efficacy if the assets appreciate. The interest on the note will be the applicable federal rate (AFR) at the sale date. This transaction is particularly attractive in today s low interest rate environment (AFR is 0.87% for loans with a term of three to nine years in January 2013). Loan to preserve a step-up in basis. Gifting low-basis assets is generally not optimal, as they do not receive a step-up in basis when the donor dies. To preserve the step-up in basis even as you make a gift this year, consider borrowing at today s low interest rates and giving cash while retaining the low basis asset. Upon the donor s death, the low-basis assets can be sold by the estate to repay the loan without incurring capital gains tax. Spousal contingent beneficiary trust. Concerns about losing recourse to assets that you gift may be somewhat alleviated if you give the assets to an irrevocable trust that names your spouse as a contingent beneficiary who may receive distributions at the discretion of independent trustee(s). However, it is important to note that if each spouse creates such a trust for the other, care must be taken. These trusts must differ in significant ways so that they avoid the adverse consequences of the reciprocal trust doctrine. 2 Grantor retained annuity trust (GRAT). The new law does not affect GRATs, which are still an excellent wealth-transfer tool with hurdle rates at historical lows (1.0% for January 2013). A GRAT transfers future appreciation to heirs free of transfer tax and without the use of any gift tax exemption. GRATs are especially effective for assets that have significant appreciation potential, even those that have considerable downside risk. Because GRATs can be structured so that no exemption is used, beneficiaries are not penalized if asset values decline. There is some uncertainty around the future of GRATs, so it may be wise to make use of this tool now. Annual exclusion gifts. The annual exclusion amount for 2013 is $14,000, up $1,000 from last year. This amount can be gifted to any number of people each year. Among other things, annual exclusion gifts can be used to fund 529 plans. Gifts beyond exemption limits. Even if a gift s value exceeds current exemption limits, it is still tax efficient to transfer wealth by making a taxable gift. In addition to removing any future appreciation on the gifted assets from the estate, taxable gifts have the benefit of being tax exclusive meaning tax is paid on the amount beneficiaries ultimately receive. This differs from the estate tax, which is tax inclusive ; that is to say, the tax is imposed on the gross amount of assets, which includes the amount used to pay the tax. Because of this difference, the effective rate of the current 40% gift tax is actually about 28.6%, as compared to the 40% federal rate for the estate tax. Taxpayers often have reservations about making taxable gifts because they fear losing access to assets or paying a gift tax while the future of the estate tax is uncertain. 2 The U.S. Supreme Court, in U.S. v. Grace Estate, 395 U.S. 316, stated that the test to determine whether the reciprocal trust doctrine applies is whether the trusts are interrelated and the arrangement to the extent of mutual value leaves the settlors in approximately the same economic positions they would have been in had they created trusts naming themselves as life beneficiaries.

10 10 in your interest However, given the permanency of the estate/gift/gst exemptions under the new Act, as well as the current fiscal condition, it is unlikely that the estate tax will be repealed in the foreseeable future. 5. REVIEW YOUR ESTATE PLAN TO ENSURE IT MEETS YOUR GOALS Estate plans should be reviewed in light of the American Taxpayer Relief Act of 2012 to ensure that wills and trusts are still consistent with your objectives. It is also important to keep in mind: Portability. Your will or revocable trust can be drafted to give a surviving spouse the option of applying the deceased spouse s exemption to assets of the estate or, instead, using the exemption him/herself later, for example, through lifetime giving. However, portability of unused exemptions does not extend to GST taxes. In other words, while a surviving spouse can apply any unused exemption for gift and estate taxes, he or she will not be able to do so for GST taxes. This reinforces the importance of maximizing available GST exemptions now. WHAT IS YOUR EFFECTIVE ESTATE TAX RATE NOW? It differs across the country, depending on each state s estate tax rate If you live in: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Florida, Georgia, Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Michigan, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Mexico, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia, Wisconsin, Wyoming Your effective estate tax rate is: 40% Connecticut, Maine 47.2% Delaware, District of Columbia, Hawaii, Illinois, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Oregon, Rhode Island, Vermont 49.6% Washington 51.4% State estate taxes. The Act allows a federal deduction for state estate taxes paid. Taxpayers affected by a separate state estate tax may find that amounts owed are significant, given the potential difference between many states exemption amounts and the federal exemption of $5.25 million. Lifetime transfers are even more beneficial for donors who reside in states that have independent estate taxes but which impose no gift tax on lifetime transfers. This is especially important given the potential differential in many state and federal exemption levels. BENEFIT OF $5.25 MILLION GIFT IN A 16% ESTATE TAX STATE A lifetime gift by a donor generates a 44.7% increase in assets available to heirs in states with high estate taxes $MM Assets to heirs No planning 6. CONSIDER YOUR DOMICILE Estate tax 44.7% increase 2.54% of annual outperformance Assumptions: $5.25 million gift, 5% after-tax investment return, 20 year time horizon, 49.6% effective estate tax rate (40% federal, 16% state, adjusted for deductibility). If you live in a high estate tax state, lifetime gifts are even more important as a way to trim your overall estate tax burden. If you have a second home in a lower tax state, also review whether it is preferable for you to shift your domicile to the lower-tax state. (See What is your effective estate tax rate now? and Benefit of $5.25 million gift in a 16% estate tax state, on this page.) A shift in domicile, made for estate tax purposes, might also bring lower income tax rates once residency is established. Gift

11 in your interest 11 STILL AHEAD Although many provisions of the American Taxpayer Relief Act of 2012 are said to be permanent, this status just indicates they are not scheduled to expire automatically. There are still many fiscal and tax issues left unaddressed by this legislation. As lawmakers discuss increasing the federal debt limit and addressing mandatory sequestration spending cuts, they will no doubt be looking for additional sources of revenue. Any of the Act s provisions may be amended by further legislation. Your J.P. Morgan Private Bankers and Wealth Advisors can work with you and your tax and legal advisors to examine strategies that may be appropriate for you. We also can help devise future responses to a changing tax environment. n

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