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CHRISTOPHER R. HOYT University of Missouri - Kansas City School of Law

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  1. Planning Strategies for Best Results for 3.8% Surtax & 2014 Expiration of Charitable IRA RolloverEast CoastEstate Planning CouncilPalm Beach Gardens – January 21, 2014 CHRISTOPHER R. HOYT University of Missouri - Kansas City School of Law

  2. INCOME TAX RATES INVEST WAGES LTCG Income Level -MENT(+1.45%)& Divid AGI < $200k/$250k 28% 29.4% 15% Congratulations! Brilliant tax planning! “Bush tax cuts” remain in full effect for people with adjusted gross income under $200,000 ($250,000 on a joint return)

  3. INCOME TAX RATES INVEST WAGES LTCG Income Level -MENT(+1.45%)& Divid AGI < $200k/$250k 28% 29.4% 15% AGI > $200k/$250k 33% 34.4% 15% 33% rate when taxable income > $183,250 -- single > $223,050 – married filing jointly

  4. TAX RATES paid on TAXABLE INCOME ADJUSTED GROSS INCOME (“AGI”) • Minus: Greater of -- Standard Deduction ($6,100) or -- Itemized Deductions (Mortgage interest; charitable contributions; state & local taxes) • Minus:Personal Exemption & Dependents ($3,900 each) = TAXABLE INCOME

  5. WEALTHY PAY SOME TAXES ON “AGI” ADJUSTED GROSS INCOME (“AGI”) • Minus: Greater of -- Standard Deduction ($6,100) or -- Itemized Deductions (Mortgage interest; charitable contributions; state & local taxes) • Minus:Personal Exemption & Dependents ($3,900 each) = TAXABLE INCOME

  6. INCOME TAX RATES INVEST WAGES LTCG Income Level -MENT(+1.45%)& Divid AGI < $200k/$250k 28% 29.4% 15% AGI > $200k/$250k 33% 34.4% 15% 33% rate when taxable income > $183,250 -- single > $223,050 – married filing jointly

  7. INCOME TAX RATES INVEST WAGES LTCG Income Level -MENT(+1.45%)& Divid AGI < $200k/$250k 28% 29.4% 15% AGI > $200k/$250k 33% 34.4% 15% plus health care surtax 3.8% 0.9% 3.8% 36.8% 35.3% 18.8%

  8. 0.9% MEDICARE SURTAX:When CompensationExceeds $200,000 ($250,000 married joint return) • Compensation -- wages & self-employment income (Added to 1.45% Medicare/Medicaid tax ) (Employee pays entire 0.9%; no employer match) • Employer must withhold when W-2 Form compensation exceeds $200,000 • Married joint? Together over $250,000? -- Pay on Form 1040 if neither spouse has over $200,000 . (e.g., Husband has $100k and Wife has $160k = $260k)

  9. 3.8% Net Investment Income TaxMAGI > $200,000 ($250,000 joint returns) 3.8% surtax on the lesser of: • Net Investment Income or • MAGI over $200,000 ($250,000 joint) ( $200k/$250k not indexed for inflation ) Trusts and estates pay 3.8% at $11,950

  10. 3.8% Net Investment Income TaxMAGI > $200,000 ($250,000 joint returns) Net Investment Income • Interest & Dividends • Annuities • Rents & Royalties • Profits from LLC / S Corp (if not employed) • Business of trading commodities & fin instruments • Most capital gains

  11. 3.8% Net Investment Income TaxMAGI > $200,000 ($250,000 joint returns) Income Exempt from Surtax: • Trade / Business income from an LLC, partnership or Subchapter S corporation provided the recipient is employed at the business. -- “material participation” test (work 500+ hours during the year?) • Gain from selling property used in trade/ business [rental property gains -> 3.8% tax]

  12. 3.8% Net Investment Income TaxMAGI > $200,000 ($250,000 joint returns) Other Income Exempt from 3.8% Surtax: Income that isn’t interest, rents, gains, etc : • Retirement income – social security, qualified plans: IRAs, 401(k), pensions, etc – (non-qualified annuities are subject to tax) • Wages & self-employment income ( 0.9% tax) • Alimony income • Lottery winnings

  13. INCOME TAX RATES INVEST WAGES LTCG Income Level -MENT(+1.45%)& Divid AGI < $200k/$250k 28% 29.4% 15% AGI > $200k/$250k 33% 34.4% 15% AGI > $250k/$300k33% 34.4% 15% -- 3% phase-out itemized deductions -- Phase-out personal exemptions

  14. PHASEOUTSAGI > $250,000 ($300,000 joint returns) • 3% Phase-out Itemized Deductions -- disguised 1% tax rate hike (3% x 33% rate) • Personal and Dependent Exemptions -- $3,900 apiece for self & each dependent -- lose 2% for every $2,500 income increase -- 100% eliminated AGI > $372k ($422k jnt) (Phase-out $250k-$372k ( $300k-$422k jnt))

  15. INCOME TAX RATES INVEST WAGES LTCG Income Level -MENT(+1.45%)& Divid AGI < $200k/$250k 28% 29.4% 15% Taxb>$400/$450 39.6% 41.0% 20%

  16. INCOME TAX RATES INVEST WAGES LTCG Income Level -MENT(+1.45%)& Divid AGI < $200k/$250k 28% 29.4% 15% Taxb>$400/$450 39.6% 41.0% 20% plus 3% phase-out 1% 1 % 1% plus health care surtax 3.8% 0.9% 3.8% With $12,000+ income, 44.4% 42.9% 24.8% Trusts & Estates >> 43.4% 23.8%

  17. 3.8% Net Investment Income TaxMAGI > $200,000 ($250,000 joint returns) Two Ways to reduce the 3.8% surtax : #1 - Reduce Net Investment Income and/or #2 – Reduce AGI to less than $200,000 ($250,000 joint)

  18. 3.8% Net Investment Income TaxMAGI > $200,000 ($250,000 joint returns) Strategies for three different taxpayers: #1 - Richest 1% - Income over $400,000 -- Reduce NII (not likely to get AGI <200k) #2 – Taxpayers with AGI near $200k ($250 jt) -- Either reduce NII or reduce AGI #3 - Taxpayers with AGI below $200k ($250 jt) -- Avoid spikes in income that trigger 3.8% tax

  19. Reduce Net Investment Income Two Ways to reduce Net Investment Income: #1 - Convert NII into income that isn’t NII #2 – Shift NII to family and to charity that aren’t subject to tax on their NII

  20. Reduce Net Investment Income Convert NII into Income That Isn’t NII #1 - Taxable interest to tax-free muni interest #2 – Life insurance #3 – Work 500+ hours at business #4 – Monster-size Roth IRA Conversions

  21. Roth IRA Conversions Reg IRABrokerageRoth IRA Assets $300,000 $120,000 -0- 5% income $15,000 $6,000 Tax Rate 39.6% 43.4%/23.8% Tax -5,940-1,428 $13,632 $9,060 $4,572

  22. Roth IRA Conversions Do a Roth IRA Conversion of IRA • Triggers $300,000 of taxable income • Taxed at 39.6% rate (no 3.8% surtax) • Use $120,000 in brokerage to pay tax CONCEPT: You have moved $120,000 from taxable account into tax-exempt Roth IRA; Moved income out of 3.8% surtax account

  23. Roth IRA Conversions Reg IRABrokerRoth IRA Assets $300,000 $120,000 $300,000 5% income $15,000 $6,000 $15,000 Tax Rate 39.6% 44.4%/23.8% 0% Tax -5,940-1,428. -0- $13,632 $9,060 $4,572 $15,000

  24. Roth IRA ConversionsChildren liquidate inherited accounts? Reg IRABrokerageRoth IRA Assets $300,000 $120,000 $300,000 Tax Rate 39.6% -0- -0- Tax -120,000 -0- . -0- $300,000 $180,000 $120,000 $300,000 The $420,000 of assets were only worth $300,000, after-taxes. (IRA: pre-tax income)

  25. Reduce Net Investment Income Shift NII to Family/Charity who pay no 3.8% tax [note: trusts do pay 3.8%] Family: Give income-generating investments Charity: #1 – Make gifts with appreciated stock #2 – Donor advised funds & private foundations #3 – Charitable lead trusts

  26. WHICH ASSET TO GIVE ? PLANNING FOR CHARITABLE GIFTS OF APPRECIATED STOCK IN LIGHT OF FUTURE TAX RATE CHANGES

  27. DONORS LIKE TO CONTRIBUTE APPRECIATED STOCK DOUBLE-TAX ADVANTAGE • Charitable Income Tax Deduction for the Full Appreciated Value of the Stock • Never Pay Income Tax on the Growth of the Value of the Stock • Loss Property? Sell for tax loss; give cash

  28. DOUBLE BENEFIT FROM GIFT OF APPRECIATED L.T.C.G. PROPERTY << AVOID LONG-TERM CAPITAL GAIN TAX << CHARITABLE INCOME TAX DEDUCTION

  29. $ BenefitsMax Federal Taxes Saved Person in 2012 50% * 25% RE Dep Recap * 28% Collectibles << 15%* LTCG Tax Rate << 35% Marginal Tax Rate

  30. IMPACT OF INDIVIDUAL INCOME TAX RATE CHANGES in 2012 and 2013

  31. FUTURE INCOME TAX RATES Highest tax rates 20122013 Investment income 35% 44.4% Earned income 36.4% 43.0% (wages – 1.45% health) LT Capital Gains15% 24.8%

  32. $ BenefitsMax Federal Taxes Saved Person in the Year 2012 50% * 25% RE Dep Recap * 28% Collectibles << 15%* LTCG Tax Rate << 35% Marginal Tax Rate

  33. $ BenefitsMax Federal Taxes Saved Person in the Year 2013 65.4% * 29.8% RE Dep Recap * 32.8% Collectibles << 24.8%* LTCG Tax Rate << 39.6*% Marginal Tax Rate (3.8% surtax not avoided by charitable deduction)

  34. Reduce Net Investment Income Shift NII to Family/Charity who pay no 3.8% tax [note: trusts do pay 3.8%] Family: Give income-generating investments Charity: #1 – Make gifts with appreciated stock #2 – Donor advised funds & private foundations #3 – Charitable lead trusts

  35. SO YOU WANNA BE A PHILANTHROPIST? Administrative Convenience of Donor Advised Funds & Private Foundations – split large gift to many charities -- one receipt from DAF/PF instead of many CWAs from many charities -- anonymous gifts possible with DAFs

  36. ShiftNet Investment Income Client with $400,000+ of income says: • “My $100,000 investment produces $4,000 of taxable income every year” • “I give away $4,000 to charity every year” • “I want a charitable bequest of $100,000” CONCEPT: Put $100,000 into a DAF while alive. Reducing NII by $4,000 beats itemized deduction.

  37. Reduce Net Investment Income Shift NII to Family/Charity who pay no 3.8% tax [note: trusts do pay 3.8%] Charity: #1 – Donor advised funds & private foundations #2 – Charitable lead trusts COST/BENEFIT – Is administrative cost of PF or CLT worth doing just for 3.8% tax savings? Other benefits are needed. ( Compare: DAF cheap!)

  38. Taxpayers with AGI Near $200,000 Two Ways to reduce the 3.8% surtax : #1 - Reduce Net Investment Income and/or #2 – Reduce AGI to less than $200,000 ($250,000 joint)

  39. Taxpayers with AGI Near $200,000 and with lots of Net Investment Income Reduce AGI to less than $200k ($250 jnt) • Reduce NII (see strategies listed earlier) • Avoid large Roth IRA conversions • Maximize compensation deferral -- 401(k) contributions -- Non-qualified deferred comp (Sec. 409A) • “Charitable IRA Rollover”

  40. Taxpayers with AGI Near $200,000 ”Charitable IRA Rollover” - over age 70 ½ • “QCD” – Qualified Charitable Distribution • Have charitable gift made directly from IRA to charity (max: $100,000 /year) • QCD distribution not counted as income (Price? No itemized charitable deduction) • QCD can satisfy annual RMD

  41. REQUIRED MINIMUM DISTRIBUTIONS*LIFETIME DISTRIBUTIONS* Age of Account OwnerRequired Payout 70 1/2 3.65% 75 4.37% 80 5.35% 85 6.76% 90 8.75% 95 11.63% 100 15.88%

  42. ADVANTAGES OF ROTH IRAs • Unlike a regular IRA, no mandatory lifetime distributions from a Roth IRA after age 70 ½ • Yes, there are mandatory distributions after death

  43. Taxpayers with AGI Near $200,000 and with lots of Net Investment Income ”Charitable IRA Rollover” - over age 70 ½ 71 year old professional • $150,000 compensation income • $50,000 net investment income • This year: first RMD from IRA ($40,000) • Intends to make charitable gift: $30,000

  44. Taxpayers with AGI Near $200,000 ”Charitable IRA Rollover” - over age 70 ½ Normal Gift Compensation $150,000 Investment 50,000 IRA RMD 40,000 AGI $240,000 << 3.8% surtax Taxable Income $210,000 on $40,000

  45. Taxpayers with AGI Near $200,000 ”Charitable IRA Rollover” - over age 70 ½ Normal GiftIRA Gift Compensation $150,000 $150,000 Investment 50,000 50,000 IRA RMD 40,00010,000 AGI $240,000 $210,000 3.8% surtax on: $40,000$10,000

  46. Will Law Be Extended to 2014? Proposed: Public Good IRA Rollover Act of 2013 Expand law to include deferred gifts; DAFs; SOs >Planning strategy for 2014 if, as in 2008, 2010 & 2012, law has not been extended until December!: • Give RMD to charity; • can’t lose ! (Some IRAs balk)

  47. 3.8% Net Investment Income TaxMAGI > $200,000 ($250,000 joint returns) Strategies for three different taxpayers: #1 - Richest 1% - Income over $400,000 -- Need to reduce NII (won’t have AGI <200k) #2 – Taxpayers with AGI near $200k ($250 jt) -- Either reduce NII or reduce AGI #3 - Taxpayers with AGI below $200k ($250 jt)

  48. Taxpayers with AGI Under $200,000 Keep AGI Under $200,000, and prepare for future years • Modest-size Roth IRA conversions ($200,000 threshold not indexed for inflation) • Modest-size capital gain harvesting • Avoid spikes in income -- Installment sales -- Charitable remainder trusts

  49. CHARITABLE REMAINDER TRUSTS

  50. CHARITABLE REMAINDER TRUSTS • Payment to non-charitable beneficiary (ies) for life *or* for a term of years (maximum 20 years) • Remainder interest distributed to charity • Exempt from income tax