BY FRAN O’ROURKE
Since the American Taxpayer Relief
Act was enacted in 2012, the tax burden
for affluent Americans–in many cases
also business owners–has increased
significantly.
Including the 3.8 percent Medicare surtax
on investment income and phase out
of itemized deduction to the highest rate
of 39.6 percent, the top marginal federal
tax rate on ordinary income is about 44.6
percent.
In addition, the top rate for qualified
dividends and long-term capital gains is
about 25 percent. Not to mention state
income tax, which in New York adds another
8.82 percent of your income to your
overall tax burden.
The following 10 wealth planning strategies
can help you take advantage of all
available opportunities to reduce your tax
bill. The key is that you must plan early.
1. Navigate the new income, capital
gains, and Medicare surtax tax brackets.
Deferring compensation or capital gains
may keep some taxpayers from jumping
into a higher tax bracket. For instance,
a taxpayer making $350,000 in taxable
income who plans to sell an asset for a
$300,000 gain would see most of the gain
taxed at 23.8 percent. Selling the property
on an installment sale or using a charitable
remainder trust to spread out the
income over several years may keep that
gain taxed at only 18.8 percent–a potential
tax savings of nearly $15,000.
2. Review your investment portfolio. An
investment portfolio should be diversified
to reduce risk, but it should also be tax
efficient. Investors on the cusp of higher
tax brackets may consider investing more
in tax-exempt bonds or growth stocks
that pay fewer dividends. Placing more
assets in tax-deferred accounts may also
be considered.
3. Take advantage of interest expense.
Structure debt in a tax-efficient manner.
Few people know that interest expense
on debt that is used to acquire “taxable
investments” is deductible. Since
investment interest expense can also be
deducted against the Medicare surtax, it
may be even more valuable than the mortgage
interest deduction. Even less well
known is that cash accounts–whether
or not interest-bearing–can constitute
a taxable investment for purposes of the
deductions.
4. Leverage IRA contributions and Roth
conversions. Self-employed taxpayers may wish to consider establishing SEP-IRA or
other retirement plans, even for a side
business. All taxpayers, regardless of income,
have the option of converting their
traditional IRA to a Roth IRA. Roth IRAs do
not require minimum distributions at age
70½ and allow for tax-free income during
retirement and for beneficiaries.
5. Use appreciated securities for year-end
charitable gifting. The after-tax cost
of a cash gift of $10,000 from an individual
in the top bracket is $6,040. On the other
hand, the after-tax cost of a gift of $10,000
worth of zero-basis stock is just $3,540. In
addition to the value of the deduction, the
donor avoids $2,500 in capital gains tax.
6. Take advantage of low interest rates.
Consider refinancing intra-family loans
and installment sales to trusts. These
loans can be as low as .32 percent short
term. The minimum rate for three to nine
year loans changes monthly; in 2014, the
rate has varied from 1.75 percent to a high
of 1.97 percent.
Families of wealth can use these rates
to transfer considerable wealth free
from gift, estate and generation-skipping
transfer (GST) tax. Low interest rates
also create the opportunity to shift significant
wealth by using estate planning
techniques, such as Grantor Retained
Annuity Trusts (GRATs) and Charitable
Lead Annuity Trusts (CLATs).
7. Consider the annual exclusion, increased
lifetime gift tax exclusion and
529 plans. The annual gift tax exclusion
for non-charitable gifts is indexed for inflation
and is now $14,000 per donor per
donee. If the intended donee is a potential
future college student, consider gifting
to a 529 plan, which can offer income tax
deferral, asset protection, the ability to
change beneficiaries and the ability to
“front load” five years of annual exclusion
gifts. Irrevocable trusts can also better
exploit large gifts.
Also, taxpayers who used up their full
unified credit amount in 2012 should
remember that, due to inflation adjustments,
they received an additional
$130,000 of applicable exclusion amount
in 2013 and an additional $90,000 in
2014. A married couple who used up their
credit in 2012 can make additional gifts of
$440,000 this year along with their annual
exclusion gifting.
8. Review estate plans. Now that the exclusion
is “permanent,” taxpayers should
reevaluate any tax-motivated clauses or
bequests in their will or trust. Consider
adding flexibility through clauses such as
powers of appointment or trust protector
provisions to allow adaptations to future
tax changes.
9. Exploit basis and income tax planning
loopholes in bypass and other irrevocable
trusts. With fewer estates being
subject to an estate tax and capital gains
tax rates increasing, trustees should consider
adding provisions to enable capital
gains to be taxed to beneficiaries who may
be in lower tax brackets than the trust.
10. Exploit estate planning loopholes
before future “revenue raisers” are passed.
Many successful estate tax planning
techniques could be adversely affected by
changes Congress and the Obama Administration
are considering, such as valuation
discounts for family LLCs or partnerships,
GRATs, dynasty trusts, irrevocable
grantor trusts and “Crummey” provisions
that enable better exploitation of the annual
exclusion. Taxpayers with estates in
excess of $5.3 million ($10.7 million for a
married couple) should strongly consider
the potential impact of these changes and
discuss planning strategies to deal with
their impact with their private banker.
O’Rourke is senior vice president of Key
Private Bank in the Capital Region.
Photo Courtesy Key Bank