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 noncharitable
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 KeyBank