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Planning With Certainty


After the many changes in the income tax and estate tax areas at the end of 2012, it is a welcome relief to have some degree of certainty this year. Well, at least we know what the rules are now, even though soon after the changes in the American Tax Relief Act of 2012 (ATRA) became law late last year, the proposals for changes to these “permanent changes” started to come forth. Now is a great time for you to think about how these changes will affect you and your tax and estate planning. What should you be thinking about in the income tax and estate planning areas? You now have just four short months to address any planning that should be done before year end. Here are some ideas of what you might want to consider:

Income Tax Planning

Income tax planning has become much more complex for those at higher income levels. We now have four tiers of taxes to worry about – regular income tax, alternative minimum tax, the 3.8% Medicare surtax, and the higher ordinary and capital gains tax rates. The applicability of the higher rates is driven by your Adjusted Gross Income, but with so many different levels that come into play, you need a cheat sheet to know what applies to your situation. If your income is over $400,000 for an individual or $450,000 for a joint return, the higher rates (ordinary income of 39.6% and capital gains/qualified dividends of 20%) apply to you.  The Medicare surtax of 3.8% on investment income however applies at lower income levels of $200,000 for an individual and $250,000 for married filing joint.

It is more critical than ever to do careful tax planning this year. Knowing where your income will fall is an important element of what tax rate you will face. Looking at your estimated tax situation and how much you have paid in through estimates or withholding will be especially important in 2013. If you accelerated capital gains into 2012 to take advantage of rising rates, you may not want to base your estimates on this “safe harbor” because your 2013 tax may in fact be lower. Alternatively, if you are in the higher income brackets and subject to the surtax and higher rates, you could see a significant jump in your tax rate in 2013.

This tax increase can also have a real impact on your long term financial planning. It might be a good time to revisit any tax assumptions in your planning to make sure that you have used good numbers. We tend to lean toward conservative assumptions when working with clients on their long term goals, but it is always good to get a reality check on the tax element of your planning since it is becoming an increasingly critical piece of your overall personal financial planning.

Estate Planning

As you may have heard, the $5.25 million exemption for Federal Estate Tax was made permanent as part of the changes in ATRA late in 2012. This exemption is indexed for inflation going forward, so if you are spending down your asset base you might need to do some projections to see where you stand in the future relative to the exemption based on various assumptions. Now only the very wealthy (over this $5.25 million /$10.50 million joint exemption amount) need to focus on the Federal Estate Tax aspects of their estate planning. For those individuals, many of the strategies we have talked about over the past few years are still very viable. Perhaps even more so now as a number of these may come under attack from the Obama Admistration (GRATS, Family Limited Partnerships, Grantor Trusts, etc.) With a 40% estate tax rate, it is still very important for those individuals over these levels to address their estate plans in light of the federal estate tax.

Estate planning can now often become more closely intertwined with income tax planning. If you hold assets until your death, you receive a “stepped up basis,” so any built in capital gains essentially disappear at death. The tradeoff is that the asset is included in your estate and may be subject to estate tax. Good planning must look at the tradeoffs between moving assets out of your estate to minimize your estate tax vs. holding the assets until death and avoiding the capital gains taxes for your heirs forever.

Unfortunately, estate planning for those under these levels has, in many cases, also gotten more complex because of the potential application of state estate taxes.  Many states have decoupled their estate tax from the Federal tax. For instance, Maryland has an exemption of only $1 million, making planning for the estate tax here a good bit more complex. You may need to take the state issues into account in any estate planning you are doing now.

Another change in ATRA made “portability” permanent. This is the ability of a spouse to utilize their deceased spouse’s exemption amount, even if proper planning was not done. While this is a great fallback if proper planning was not done before death, it has some real drawbacks and should not replace good planning. While portability applies to the estate and gift tax, it does not apply to the Generation Skipping Tax (GST). There is also no “inflation protection” when using portability for your planning, unlike if you have a credit shelter trust that you can fund with the exemption amount and get the future value of those assets out of both spouses estates.

So as you can see from this brief overview, simplicity was not part of the tax changes in Washington at the end of 2012. However, we believe these changes have created unique opportunities as well as the need to reevaluate your income tax and estate planning situation in 2013. Tax planning is an increasingly important part of your overall personal financial planning.  As always, please let us know if we can help you in this process!