Tax Alert

This Alert is to bring your attention to the window that we have to take advantage of certain preferential tax exemptions and rates and how fast that window is closing. The 2010 Tax Reform Act extended certain beneficial rates and exemptions until December 31, 2012. We are now in October and technically we have until December 31, 2012 to take advantage of these favorable tax rates and exemptions unless Congress takes some action to change that date. The following is a summary of the important provisions affecting your income and estate taxes.

Estate and Gift Tax

  • In 2011 and 2012, the 2010 Tax Reform Act increased the federal estate, gift and generation-skipping transfer tax exemptions to $5 million per taxpayer and $10 million per couple. After 2011, the exemption amounts are indexed for inflation in increments of $10,000. In 2012, the exemption increased to $5.12 million and $10.240 million respectively. The maximum tax rate on taxable transfers is 35%.
    In 2013, the estate and gift tax exemption will revert to a $1 million exemption and the generation-skipping transfer tax exemption will revert to $1.4 million, all with a top tax rate of 55%.
  • The new law reunifies the estate and gift taxes for the same two-year period, effective for gifts made after December 31, 2010. This means that the $1 million gift tax exemption that was applicable to years prior to 2011 was increased to $5 million for 2011 and $5.12 million for 2012.

Income Tax
There were also a number of other income and employment tax provisions that will expire at the end of 2012. Some of the more interesting provisions are summarized below:

*2013 rate applies to married couples with adjusted gross income of $250,000 ($200,000 for single taxpayers)

2012 2013
Top Income Tax Rate 35.00% 39.60%
Top Rate on Long Term Capital Gain 15.00% 20.00%
Top Rate on Qualified Dividends 15.00% 39.60%
Social Security Tax Rate for Employees 4.20% 6.20%
Medicare Tax* 1.45% 2.35%
Investment Income Excise/Surtax* 0.00% 3.80%

What Individuals should do?

  1. Make gifts before the end of 2012 to take advantage of the increased gift tax and generation skipping transfer tax credit.
  2. Sell appreciated long-term capital gain assets in 2012 if it otherwise makes sense, thereby avoiding the increase in the capital gain tax rate (20%) and 3.8% excise/surtax in 2013.
    • Consider buying back the asset to increase your cost basis.
  3. Consider accelerating income into 2012 and delaying deductible expenses into 2013.
  4. Pay careful attention to the timing of certain deductions, e.g. charitable gifting. The increase in tax rates would make your deductions worth more in 2013 than in 2012. However, limits on the amount of allowable deductions in 2013 could reverse this logic.
  5. Delay recognition of losses. Unlike most years, you may want to delay recognizing losses until 2013 as having those losses in future years to offset gains may be more valuable.
  6. Individuals with IRA’s whose income is close to the $200,000/250,000 threshold, consider converting to a Roth IRA to eliminate the increase in AGI as a result of RMDs.
    • Convert in 2012 to avoid 39.6 % tax rate and 3.8% excise/surtax.
    • Need to have other assets to pay tax on conversion.
    • Must meet the 5 year hold requirement.
  7. Mortgage Refinancing. Mortgage rates are at historic lows. Even if you recently refinanced, it still may be a good time to refinance as rates have dropped significantly in 2012.

What should Trusts do?
3.8% excise/surtax applies to assets held in Trust. Trust threshold is $11,650 (in 2012) rather than $250,000.

  1. Payout as much of the investment income as possible to have income taxed at beneficiary’s bracket with a higher threshold.
  2. Design new Trusts as Grantor Trusts for income tax purposes.

Additional Medicare Tax on Earned Income
additional 0.9% Tax on Wages:

  1. Accelerate expected bonuses into 2012, rather than 2013.
  2. Consider taking advantage of the Section 83(b) election. Under this code section an employee may elect to include the fair market value of restricted stock (less any amount paid for such stock) in compensation income in the year the stock is received.
  3. If possible, have restricted stock vest early.
  4. Consider exercise of employee stock options in 2012.

General Strategy
Consider products/investments that are tax deferred and/or tax free in order to avoid increased federal income tax, dividend/capital gain rates and the additional 3.8% excise/ surtax. It is important to focus on the possible impact that the tax rate uncertainty has on markets. We would be happy to review your overall portfolio and current asset allocation and discuss any necessary changes.

In spite of that deadline, for practical purposes we are recommending that if you want to take advantage of any of this year’s favorable tax rates and exemptions, you should do it as soon as possible. There are a number of reasons for this. For gifting purposes, valuation companies are extremely busy and may be slow to complete valuations by year-end. If the gift is of a hard to value asset like an interest in a closely held S Corporation, or a Hedge Fund or Private Equity Company, or an interest in an intervening entity like a Family LLC is being transferred, months may be needed to get this valuation done.

Also, if gifting involves a husband and wife where each will have a trust, a substantial period of time between the creation of the trust for one spouse and the creation of the Trust for the other spouse may be necessary to avoid those trusts being treated as Reciprocal Trusts.

And finally, attorneys that we work with are advising that the whole gifting process be started as soon as possible so that the necessary planning and document preparation and review can get done without creating the stress and pressure on all parties concerned (including our clients) as the result of a year-end fire drill.

Please contact us immediately if you would like to discuss the impact that the above changes have on your overall plan. We would also be happy to explore strategies that may be appropriate for meeting your planning objectives.

This memorandum was produced by Summit Financial Resources, Inc., 4 Campus Drive, Parsippany, New Jersey 07054. Phone: 973-285-3600, Fax: 973-285-3666. It is for your information and guidance and is not intended as legal or tax advice to you or your clients. Legal and/or tax counsel should be consulted before any action is taken. Consult your advisor at Summit Equities, Inc. prior to any investment implementation. Investment and advisory services are offered through Summit Equities, Inc.

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