The current gift, estate and generation-skipping transfer tax (GSTT) exemption of $5,120,000 is scheduled to sunset at the end of this year. If Congress takes no further action, the equivalent exemption will drop to $1 million next year, and estate tax rates will return to 55 percent (up from 35 percent).
In order to take advantage of the current historically high gift-tax exemption, clients may consider transferring assets out of their estate prior to year-end.
Transferring assets out of your estate to irrevocable life insurance trusts, family limited partnerships, or irrevocable grantor trusts can minimize estate taxes and protect assets for future generations.
Transfer assets to generation-skipping (or dynasty) trusts to benefit future generations while taking advantage of the GSTT exemption.
Beginning January 1, 2013, higher-income taxpayers will also be subject to a 3.8-percent tax on certain investment income. The tax is on the lesser of net investment income or the excess of modified adjusted gross income (MAGI) attributed to net investment income over a certain threshold amount (i.e., $200,000 filing single/$250,000 married filing jointly).
Investments subject to this surtax are taxable interest, capital gains, dividends, nonqualified annuity distributions, royalties and rental income.
Exceptions to the surtax are distributions from pensions, 401(k)s and IRAs as well as income generated from municipal bonds.
These distributions, however, will be part of your adjusted gross income (AGI) calculation.
A return to higher income tax brackets of 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent are also scheduled to take effect.
Long-term capital gains are expected to return to 20 percent for higher-income taxpayers. Short-term capital gains will be taxed at the increased ordinary income tax rates. Currently, qualified dividends are taxed at 15 percent and ordinary dividends at ordinary rates. This distinction will disappear in 2013, and tax will be paid at ordinary income rates.
What actions may be considered now to take advantage of current rates?
Consider selling any highly appreciated assets to avoid the increased income tax rates and the additional 3.8-percent investment tax. (Don’t forget the alternative minimum tax (AMT) in your calculations. The AMT doesn’t apply directly to long-term capital gains and qualifying dividends, but you must include them when calculating your taxable income under the AMT).
Consider a Roth conversion to minimize the amount of income subject to higher income tax rates in the future. Not only does money held in a Roth IRA grow tax deferred for federal income tax purposes, but distributions are also tax free if certain requirements are met.
Take income this year rather than deferring income until next year. General advice for business owners can be to defer income to the following year to help reduce the current income tax obligation. If your organization is taxed as a pass-through entity, you may want to consider accelerating revenue into 2012 to take advantage of the current lower rates. In that same regard, you may wish to defer deductions and capital losses until next year.
Tax-free investments may become more attractive. If you are in a high tax bracket, municipal bonds may offer a better after-tax return (even though taxable bonds may pay higher interest rates).
Consider maximizing contributions to IRAs and employer-sponsored retirement plans to reduce AGI below income thresholds (i.e., $200,000 filing single/$250,000 married filing jointly).
Tax-deferred nonqualified annuities and permanent life insurance may be advantageous in deferring income that would otherwise be subject to tax.
Carrie Dick is a financial adviser at Kevin Dick Investment Management Group, 715 S. Beeline Highway, Suite A. She offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. She can be reached at (928) 474-4350 or at firstname.lastname@example.org.