Individual year-end planning and tax law updates

Size: px

Start display at page:

Download "Individual year-end planning and tax law updates"

Peter Hodge
6 years ago
Views:

1 Individual yearend planning and tax law updates October 29, 2013 Baker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently owned and managed member of Baker Tilly International. 1

2 Presenters Tina D. Milligan Tax Partner Private Client Group Baker Tilly Randi A. Schuster Tax Principal Private Client Group Baker Tilly 2

3 Today s discussion > Current and future tax law landscape Income Estate, gift, and generationskipping transfer taxes > Setting the stage for tax planning > Income tax planning considerations prior to yearend > Income tax planning in a higher rate environment > Estate planning prior to yearend 3

4 Current and future tax law landscape 4

5 Top tax rates Still near historical lows Income Capital gains %

6 Income tax rates Tax rates 2012 ATRA 2013 Ordinary income 39.6% for income over threshold levels 1 35% 35% 33% 33% 28% 28% 25% 25% 15% 15% 10% 10% Alternative minimum tax 2 26% / 28% 26% / 28% Interest Ordinary income rates Ordinary income rates Long term capital gains and qualifying dividends 20% for income over threshold levels 1,3 15% 3 15% 3 0% 3 0% 3 Personal exemption phaseout (PEP) None Restored Limitations on deductions None Restored Health care reform increases None 3.8% on investment income 4 None 0.9% on earned income 1. For taxpayers whose income exceeds $450,000 for married filing jointly and $400,000 for single filers 2. ATRA permanently extended AMT relief, retroactively increasing the AMT exemption amounts and providing that the exemption amounts will be indexed for inflation 3. For taxpayers in the 10% or 15% marginal income tax bracket, special 0% rate generally applies. For taxpayers in the 25%, 28%, 33%, or 35% tax brackets, a 15% maximum rate will generally apply. Taxpayers in the 39.6% tax bracket will be subject to a maximum rate of 20%. Baker % Tilly on Virchow unearned Krause, income LLP to taxpayers above $250,000 for married filing jointly and $200,000 for single filers 6

7 Income tax rates Itemized deduction limitation. For taxpayers subject to the Pease limitation, the total amount of their affected itemized deductions is reduced by the smaller of 3 percent of the amount by which the taxpayer s income exceeds the threshold amount or 80 percent of itemized deductions that are affected by the limit. These dollar amounts are adjusted for inflation for tax years after Personal exemption limitation. Under the phaseout, the total amount of exemptions that can be claimed by a taxpayer subject to the limitation is reduced by 2 percent for each $2,500 (or portion thereof) by which the taxpayer's income exceeds the applicable threshold. These dollar amounts are adjusted for inflation for tax years after In 2013, the personal exemption amount is $3,900. Permanent AMT relief. ATRA provides permanent alternative minimum tax (AMT) relief for 2012 and beyond. In addition, for tax years beginning with 2013, these exemption amounts are indexed for inflation. Before ATRA After ATRA Married filing jointly $45,000 $80,800 Single $33,750 $51,900 Married filing separately $22,500 $40,400 In summary, the common thresholds to keep in mind are: Married filing jointly Single 39.6% income tax bracket $450,000 $400,000 Pease/PEP limitations $300,000 $250, %/0.9% Medicare taxes $250,000 $200,000 7

8 3.8% Medicare surtax Types of income subject to surtax Subject to surtax Wages Active business income Selfemployment income Gain from sale of active business Gain from sale of investments X Retirement plan distributions Taxable interest X Exempt interest Dividends X Annuity income X Passive royalty X Active royalty Rents X Exempt from surtax X X X X X X X 8

9 Estate, gift, and GST taxes Estate, gift, and generationskipping tax. ATRA prevents steep increases in estate, gift, and generationskipping transfer (GST) taxes that were slated to occur after 2012 by permanently keeping 2012 exemption level indexed for inflation. In 2013, the estate, gift, and GST tax exemption amounts are $5.25 million. However, ATRA also permanently increases the top estate, gift, and GST tax rate from 35 percent to 40 percent for 2013 and beyond. ATRA also continues the portability feature that allows the estate of the first spouse who dies to transfer his or her unused exemption to the surviving spouse. Year Estate tax exemption GST tax exemption Gift tax exemption Top estate, gift, and GST tax rate 2012 $5.12 million (portable) $5.12 million $5.12 million 35% 2013 ATRA $5.25 million (portable) $5.25 million $5.25 million 40% 2014 projected $5.34 million (portable) $5.34 million $5.34 million 40% 9

10 Portability made permanent Not applicable for state and generation skipping tax Estate tax Generationskipping tax State estate tax 1 st spouse to die 2 nd spouse to die 1 st spouse to die 2 nd spouse to die 1 st spouse to die 2 nd spouse to die Federal taxable estate Federal taxable estate Federal taxable estate Federal taxable estate Federal taxable estate Federal taxable estate $0 $10.5 million $0 $10.5 million $0 $10.5 million Federal exemption Federal exemption GST exemption GST exemption State exemption Ex. NY state exemption $5.25 million $10.5million $5.25 million $5.25 million $1 million $1 million Federal estate tax Federal estate tax GST tax GST tax State estate tax NY state estate tax $0 $0 $0 $2.1 million $0 $509,643 10

11 States with estate taxes Estate tax 2014 exemption Top rate Connecticut 1 $2 million 12% District of Columbia 1 million 16 Delaware 5.34 million 16 Hawaii 5.34 million 16 Illinois 4 million 16 Maine 2 million 12 Maryland 1 million 16 Massachusetts 1 million 16 Minnesota 1 1 million 16 New Jersey 675, New York 1 million 16 Oregon 1 million 16 Rhode Island 2 910, Tennessee 2 million 9.5 Vermont 2.75 million 16 Washington 2 2 million 20 1 Also imposes a gift tax Source: CCH 2 Plus annual inflation adjustment to be determined 11

12 Poll Do you feel prepared for the differences you will see on your 2013 tax return? 12

13 Income tax planning 13

14 Tax planning can significantly preserve your family s wealth Without tax planning, significant wealth can be lost to tax bills $ mm Aftertax value of assets with tax planning Aftertax value of assets with no planning Value lost to taxes Tax planning No tax planning 14

15 Comparing 2012 and 2013 tax Regular tax calculation Calculation of total income Employment $300,000 $300,000 Investment Interest 34,899 38,077 Dividend 47,901 52,262 Shortterm capital gains 7,913 8,634 Ordinary business income 306, ,652 Total income 697, ,624 Total tax calculation Regular federal tax 183, ,962 Alternative minimum tax 1,785 0 Net federal tax 185, ,962 Social security tax employment 4,624 7,049 Medicare tax employment 4,350 4,800 Medicare tax unearned income 0 3,761 Illinois state income tax Total $33,904 $34,642 Summary Total taxes $228,438 $252,215 Income after tax $162,276 $146,758 Federal tax bracket 35.00% 39.60% Effective marginal tax rate 33.00% 47.61% 15

16 Income tax planning going forward > Consider deferring income > Consider deferring gain > Maximize deductions > Use taxefficient leverage, where appropriate > Consider tax efficiency in investing > Continue AMT planning > Surtax planning > Payroll tax planning 16

17 Capital losses in high vs. low tax environment Capital losses are more tax effective when used to offset income taxed at higher tax rates (e.g., shortterm capital gains and ordinary income) Shortterm gain Longterm gain Shortterm loss Neutral Ineffective Longterm loss Effective Neutral 17

18 Deductible interest may be more beneficial in a higher tax environment The aftertax cost of debt can be lower in a higher tax environment Example: > 4% interest rate loan secured by an investment portfolio > High tax environment: 43.4% highest tax bracket > Low tax environment: 35.0% highest tax bracket 5% 4% Aftertax effective interest rate 3% 2.264% 2% 2.6% 1% 0% High tax environment Low tax environment Assumes deductible investment interest expense with sufficient investment income to allow deduction 18

19 Capital gains and dividend income reduced in a higher rate environment Change in longterm capital gain and dividend tax rates from 15% to 23.8% Example: > $100 longterm capital gain > High tax environment: 23.8% longterm capital gains > Low tax environment: 15.0% longterm capital gains Net capital gains after tax $100 $80 $60 $40 $76.20 $85 $20 $0 High tax environment Low tax environment 19

20 Poll Do you plan to make charitable gifts prior to yearend? 20

21 Charitable deduction planning going forward Donating appreciated stock to charity Defer capital gain Charitable remainder trust Charitable lead trust Donating cash to charity No capital gain benefit No capital gain Directly to charitable institution Donoradvised fund Private foundation Example: $1 million gift of stock with zero basis Example: $1 million gift of cash Charitable gift $1,000,000 $1,000,000 Embedded capital gains tax liability (23.8%) (238,000) (0) Income tax benefit (342,005) (300,005) Outofpocket cost of charitable gift $457,995* $699,995* Assumes AGI $5 million. *Includes impact of itemized deduction phaseout reinstated in

22 An overview of charitable giving What are your objectives? What will the characteristics of the entity be? What assets will be used? What are the tax implications? What are the appropriate entities for me? When do you want to give? How much do you want to give? How much control do you want to retain over your charitable dollars? Will it be run individually or collectively? What level of family involvement will there be? What level of control will there be over the investment strategy and distributions? What, if any, level of anonymity do you prefer? Will the source of funding be: > Cash? > Publicly traded securities? > Private company stock? > Art? > Real estate? When will you fund? Will there be an income tax deduction? What are the capital gains taxes? What about estate taxes? Who pays them? Charitable trusts? Donoradvised fund? Private foundation? Outright gift? 22

23 Estate planning prior to yearend 23

24 Drawing your overall financial picture Personal balance sheet Included in estate Nonincludible Business owner Business owner s spouse Joint Family trust Charitable trust or private foundation ILIT for business owner ILIT for business owner s spouse Joint ILIT Total Nonqualified assets Cash Marketable securities Total nonqualified assets $1,500,000 1,500,000 $500, ,000 $500,000 1,500,000 2,000,000 Lifestyle assets Tangible property Personal residence Total lifestyle assets Business assets Business Total business assets Qualified assets 401(k) IRA Total qualified assets $5,250,000 5,250,000 1,000,000 1,000,000 1,500,000 1,500, , ,000 Objective: preserve assets from income tax and move assets from included to nonincludible to reduce estate, GST tax 1,500,000 1,500,000 5,250,000 5,250,000 1,250,000 1,250,000 Death benefit of life insurance Total assets $6,250,000 $3,250,000 $500,000 $10,000,000 Liabilities Home mortgage Private equity capital commitments Other Total liabilities Total net worth $6,250,000 $3,250,000 $500,000 $10,000,000 24

25 Estate planning prior to year end > Generous $10.5 million federal exemption > Portability made permanent, but not applicable for state or generationskipping tax > State deficits could mean additional state tax > Asset values may still be low > Shortterm GRATs remain viable for now > Family partnership discounts for now > Current estate freeze techniques can t be assumed to remain available indefinitely > Remember estate planning is not only applicable to taxable estates: Don t forget nontax estateplanning needs 25

26 Poll Do you have a will? 26

27 Wealth transfer strategies Annually Over your lifetime Transfer of wealth excluded from any gift tax Transfer of wealth through GST, estate, and gift tax exemptions Transfer of wealth utilizing discount strategies Transfer of wealth utilizing freeze strategies (appreciationonly gifts) Transfer of wealth through taxable gifts $14,000 per individual ($28,000 gift splitting with spouse) per donee Direct tuition payments to educational institution 1 Direct payments to health care provider for medical expenses 1 Gift tax exemption of up to $5.25 million per individual GST and estate tax exemptions 3 GST trust Family limited partnership (FLP) Family limited liability company (FLLC) Family corporation (C or S corporation) Grantor retained annuity trust (GRAT) Intentionally defective grantor trust (IDGT) Qualified personal residence trust (QPRT) Intrafamily loan Irrevocable life insurance trusts (ILIT) 2 Statutory freeze partnership (FLP or FLLC) 4 Spousal lifetime access trust (SLAT) Pay gift tax now rather than paying estate tax later Converting traditional IRA to Roth IRA 5 Marital trust gift planning 1 To qualify for exclusion, gifts (a) of tuition must be made directly to the educational institution; and (b) for medical expenses must be made directly to the health care provider 2 Often can be structured to use annual exclusion gifting 3 In 2013, an estate tax is assessed at a top rate of 40% with a $5.25 million estate tax exemption and a $5.25 million GST tax exemption 4 Can serve to both utilize discount and transfer wealth with freeze strategies 5 Paying the income tax in converting a traditional IRA to a Roth IRA is essentially a taxfree gift Charitable planning over your lifetime and testamentary planning (including charitable) 27 27

28 Wealth transfer strategies > Annual gift giving $14,000 cash/appreciated stock Good Closely held stock valuation discounts available Better Gift of closely held stock to a GRAT Brilliant 28 28

29 Wealth transfer strategies > Retirement planning Maximize contributions to retirement plans Good Maximize contributions to Roth retirement plans Better Employ your child and pay them enough so you can help him or her establish a Roth IRA Brilliant 29 29

30 Wealth transfer strategies > Education Direct payments for tuition are outside the annual exclusion Good Education savings accounts Better 529 plans Brilliant 30 30

31 The benefits of planning Planning Income tax planning Taxefficient leverage Asset allocation, diversification, and tax planning Appropriate acceleration or deferral of income Appropriate acceleration or deferral of deductions Estate planning Execute a basic estate plan Ensure appropriate titling of assets Fund buysell planning and/or irrevocable life insurance trust Benefit Increases tax deductions resulting in lower aftertax cost and outofpocket expense Increased aftertax return Increased aftertax dollars of income Decreased outofpocket tax cost Ensures distribution of assets as intended Avoids inadvertent estate tax liability Avoids inadvertent estate tax exposure by removing life insurance from your estate Provides for necessary liquidity to pay estate tax 31

32 Questions? Questions 32

33 Contact information Tina D. Milligan Randi A. Schuster

34 Disclosure The content in this presentation is a resource for Baker Tilly Virchow Krause, LLP clients and prospective clients. Nothing contained in this presentation shall be construed as legal advice, opinion, or as an offer to buy or sell any property or services. In conformity with U.S. Treasury Department Circular 230, tax advice contained in this communication and any attachments is not intended to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code, nor may any such tax advice be used to promote, market or recommend to any person any transaction or matter that is the subject of this communication and any attachments. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments. 34

Tax Planning Considerations for 2015

Tax Planning Considerations for 2015 Most strategies that could have an impact on your taxes need to be made by December 31 if you want them reflected on your 2015 tax return. Executive summary As the