The IRS recently issued a useful summary to taxpayers as to which gifts are taxable and non-taxable:
Dear Tax Clients:
With the year coming to an end, as always, there becomes a heightened sense of emphasis on financial and tax planning. This is true now more than ever with the future of America’s tax code being so uncertain and with many tax cuts taxpayers have taken for granted for over a decade set to expire in 2012. Knowing this, we at Hoffman & Associates, would like to help you by providing some general reminders, items of interest for the current tax year and some valuable planning tips for changes we are likely to see in the future. We hope these notes, as well as some general estate planning and business items that are of importance, will help you prepare for your 2012 taxes as well as for the future. However, as every taxpayer paints a different picture, we recommend contacting one of our tax and legal experts for reassurance or with any question you may have.
Tax planning for individuals for both the 2012 year-end and forward will be complicated for a multitude of reasons, with the most important being that most of the Bush-era tax cuts are set to expire at year end. This casts doubts about the renewal of many tax extenders, like the AMT patch, and makes the possibility of across-the-board tax hikes, including the new 3.8 percent “medicare” tax on investment income and .9 percent increase one earned income, a likelihood. Individual taxpayers will want to be sure to make the most of the favorable tax savings opportunities while they are available in 2012 because they may not see such favorable tax rules in the coming years. Although Congressional action between now and the end of the year may cause more tax changes, we have summarized below some year-end tax reminders and tips.
- Estimated Payments – Make your 4th Quarter Georgia estimated payment in December instead of waiting until January 2013, unless you are in an AMT situation (see “Current Year Items of Interest”).
- Tax Withholdings – If you have not had enough withheld from your 2012 pay, or you have missed an estimated payment, you can opt to have more tax withheld from your paycheck before year end in order to cover this potentially costly mistake.
- Sell Your “Losers” – Don’t forget to offset any 2012 capital gains. Married taxpayers can take up to a $3,000 capital loss ($1,500 for single filers). Be careful to avoid “wash sale” rules by not buying the same stock within 30 days before or after the original sale; otherwise the losses won’t count.
- Retirement Plan Contributions – Have you made your contributions to your retirement plans for 2012? The deadline for all types of IRA contributions is April 15th, 2013, you can make these contributions before the end of the year.
Items Set to Expire in 2012
- Consider Converting Your IRA – With an expected tax increase post-2012 and into the future, you may want to consider converting your Traditional IRA to a Roth IRA. You would owe tax on the IRA amount currently, to the extent it exceeds basis, but upon retirement when tax rates are expected to be higher, all the distributions from the Roth, if the holding period is met, would be tax free. The conversion of traditional IRA’s to Roth IRA’s is not an all or nothing proposition. Also, the maneuver is particularly attractive if you are experiencing an extraordinary low income or loss year.
- Alternative Minimum Tax – Unless action is taken in Congress, the exemption for AMT in 2012 will decrease to $33,750 for individuals and $45,000 for married couples. Favorable legislation passed in the House and Senate earlier in the year indicating action will be taken to increase these amounts has yet to be enacted. Therefore, taxpayers should not assume this change will take place and should be prepared if there is no increase.
- American Opportunity Tax Credit – This enhancement to the Hope Education Credit that allows for a credit of up to $2,500 per student for the first four years of post-secondary education expires after 2012. If not made permanent by Congress in 2013, it will revert back to the less generous Hope Scholarship credit (maximum credit of $1,950 and available for only two years). In contrast, the still available Lifetime Learning Credit is a per taxpayer per year credit and can be claimed for an unlimited number of years.
- Student “Above-the-Line” Expense – The Qualified Higher Education Expense deduction for tuition and fees expired last year. For those who will are paying off student loans, the student loan interest deduction after 2012 will be limited to five years and phased out at lower AGI levels.
- Social Security Payroll – Most taxpayers can expect a smaller paycheck in 2013 due to Social Security Payroll taxes withheld reverting back to their normal amounts. The social security wage base for this additional 2 percent is $113,700 in 2013 (up from $110,100 in 2012) and also applies to self-employed individuals, whose self-employment tax on social security will revert back to 15.3 percent in 2013 (up from 13.3 percent in 2012).
Tax Planning Opportunities
- Child Tax Credit – The child tax credit for 2012 is $1,000 per eligible child, but going forward will be reduced to $500. Taxpayers should plan ahead for this reduction as the refundable amount also will be limited for those with at least three qualifying children in 2013.
- Increasing Tax Rates – The current percentage rates of 10, 15, 25, 28, 33 and 35 are set to revert to the pre-Bush tax cut rates of 15, 28, 31, 36 and 39.6 percent. President Obama has proposed to keep the current structure, but replace the 33 and 35 percent rates with the 36 and 39.6 percent rates for higher income tax payers. Because of potential tax hikes across the board, taxpayers should discuss their income projections and tax plan for 2013 with both their financial advisor and tax preparer to ensure adequate estimates and withholdings, especially since the 39.6 percent top rate does not include the 3.8 and .9 percent Medicare taxes.
- Capital Gains/Losses and Dividends – Beginning in 2013, the tax rates for long-term capital gains and qualified dividends will change. The rates will move from zero percent for taxpayers in the 10 and 15 percent brackets and 15 percent for everyone else to 10 percent for taxpayers in the 15 percent bracket and 20 percent for everyone else, respectively. Dividends will be taxed at ordinary income tax rates (top rate of 39.6 percent, or 43.4 percent if the 3.8 percent Medicare tax applies. Individuals should consider accelerating capital asset sales and C Corporations may want to declare and distribute special dividends before year-end).
- 3.8 Percent Medicare Contribution Tax – 2013 also brings a new 3.8 percent “unearned income Medicare contribution” tax. The tax will target higher-income individuals, estates and trusts and will be assessed on the smaller of net investment income (NII), which is investment income minus allocable expenses, or the amount by which an individual taxpayer’s modified adjusted gross income (MAGI) is over $200,000 ($250,000 for married couples). For estates and trusts, this tax applies to the lesser of undistributed NII or adjusted gross income (AGI) in excess of $11,950 for 2013. Estates and trusts should consider distributing NII to beneficiaries whose MAGI threshold is much higher. Individual taxpayers, and certain estates with passive rental income, whose NII exceed MAGI and AGI thresholds, should re-do their triple net leases so they can actively participate in the management of their rental properties and avoid this 3.8 percent tax. Income from taxable IRAs, social security and alimony is not investment income, but increases MAGI and could subject your NII to this tax. Consider investing in tax-exempt bonds or funds which are neither included in AGI nor MAGI for investment income purposes.
- Personal Exemption Phaseout and Pease – The personal exemption phaseout (PEP) and Pease (a limitation on itemized deductions) were repealed through 2012, but could be reinstated in 2013. A reinstatement of the PEP and Pease means taxpayers that have an adjusted gross income of certain amounts (estimates of the phaseout are said to begin at $178,150 for singles and $267,200 for those married filing jointly) will lose any advantage of personal exemptions and itemized deductions. Note that medical and investment interest expenses, gambling and casualty or theft losses are not subject to the Pease limitation. Therefore, taxpayers should consider making additional gifts to charity this year. Paying state income or real estate taxes in 2012 is a good idea too, unless you are subject to the AMT.
- Medical Expense Deductions – As provisions for personal exemption phaseouts and limitations on itemized deductions are set to kick in, so is an increase to the threshold for the itemized medical deduction. Currently, medical expenses must exceed 7.5 percent of a taxpayer’s adjusted gross income (AGI) before they qualify as a subtraction to AGI. Beginning in 2013, the threshold will increase to 10 percent of AGI; however, individuals who are age 65 and older will be exempt from this increase through 2016. If possible, taxpayers under 65 years old should take advantage now of the current 7.5 percent of AGI threshold by accelerating elective unreimbursed qualifying medical expenses.
Estate planning is another important aspect of your financial well-being. This is an area of tax that is often convoluted and constantly changing. Some important and potentially drastic changes are set to expire in 2012. We have listed below the changes that we believe will have the most impact on our clients.
- Estate and Gift Tax – The 2012 estate and gift tax rate is 35 percent with an exemption of $5.12 million. This will revert back to $1 million in 2013 as the maximum tax rate reverts back to 55 percent. Also, the portability rule allowing an individual’s estate or spouse to make the election on a timely filed federal estate tax return to utilize the “deceased spouse’s unused exclusion” amount (DSUE Amount) is set to expire. If made, the surviving spouse’s unused estate and gift tax exemption amount available for gifting before the 12-31-12 expiration date, could be in excess of $10,000,000. Therefore, individuals with significant assets should consider taking advantage of the higher gift and generation-skipping exclusions now.
- 2012 Annual Gift Tax Exclusion – The annual exclusion for gifts free of any gift tax is $13,000 this year ($14,000 beginning in 2013) (married couples can gift up to $26,000) to each individual. Married donors can gift up to $26,000 in 2012 ($28,000 in 2013) per donee.
- Year End Donations – When gifting to charitable organizations consider gifting securities that have appreciated. As long as you have held the securities more than a year, you take a deduction for their market value.
Business tax planning, like individual tax planning, will become just as difficult to plan for in the coming years because of the expiring tax incentives. The tips and changes we believe will be the most significant to our clients are listed below.
- 2012 Section 179 Expense – Typically, for business property with a useful life of more than one year, the cost must be depreciated (deducted ratably over several tax years). IRC Section 179 allows the business to fully expense the cost of eligible-tangible personal property in the year purchased. The maximum amount in 2012 that may be expensed is $139,000 with a $560,000 investment ceiling placed on the purchase of all otherwise qualifying expenses. In 2013, both the Section 179 expense and investment ceiling are scheduled to drop to $25,000 and $200,000, respectively.
- Bonus Depreciation – Fifty percent first year bonus depreciation is allowed for the cost of new qualified property with a recovery period of 20 years or less placed in service (i.e., ready for use and not merely purchased) in 2012, but will expire at year end. Businesses should take advantage of these favorable expensing rules now while they are still available.
- Dividends – Closely-held C Corporations may want to declare and distribute special dividends this year so shareholders may take advantage of the lower expiring tax rates and to avoid the 3.8 percent Medicare tax on investment income.
Additional Items to Note
- IRS “Phishing” Scams – As was noted in last year’s letter, the IRS continues to battle cons taking advantage of taxpayers. They stress that the IRS does not solicit taxpayer information via e-mail and that any emails received from the “IRS” requesting personal information should be deleted immediately.
- Audits – Taxpayer audits continue to be a problem for individual taxpayers. As the Federal government continues to struggle financially, the automatic notices for audits and penalties are sent out at a staggering rate. Please let us know if you receive any notice from the IRS as we are prepared to help you if you have any issues.
As always, we encourage you to feel free to contact us with any concerns or questions you may have about your taxes.
HOFFMAN & ASSOCIATES, ATTORNEYS-AT-LAW, L.L.C.
In accordance with IRS Circular 230, this article is not to be considered a “covered opinion” or other written tax advice and should not be relied upon for IRS audit, tax dispute, or any other purpose. The information contained herein is provided “as is” for general guidance on matters of interest only. Hoffman & Associates, Attorneys-at-Law, LLC is not herein engaged in rendering legal, accounting, tax, or other professional advice and services. Before making any decision or taking any action, you should consult a competent professional advisor.
In my last column, I discussed the current fate of estate and gift tax law. The emphasis is on the prospective most significant increase in tax rates and lowering of individual exemptions that we have seen in our lifetime. For those individuals with large estates, this creates a sense of urgency for estate planning to be done between now and the end of 2012.
Today, I’d like to bring it down a notch and discuss more traditional estate planning concepts that apply to a broader cross section of individuals/clients.
I am a firm believer in trusts, hence the moniker a “trust and estate lawyer”! For the vast majority of our clients that means leaving their estates to their spouse, but directly to trusts that are created by their Wills. These trusts are most often controlled by, and for the benefit of, the surviving spouse. When property eventually goes to children, we believe that in most cases it is far more beneficial to have trusts created for your children, regardless of age, that will last for their lifetime.
If the document creating the trust (Will or trust agreement) is properly drafted, your spouse or child can be the trustee of his or her trust, effectively exerting all of the control over assets that they would have had if they inherited property outright. However, the estate tax savings for future generations, the potential avoidance of generation skipping tax, the income tax flexibility, the protection from creditors, the protection from divorce, the preservation in the family, and the avoidance of probate are some of the reasons that it is desirable to allow the property to flow from generation to generation in trusts, as long as there are any significant assets worth protecting.
The 2010 tax law introduced the concept of “portability”. This simply means that if one spouse dies and his or her estate does not use all of their estate tax exemption, the remaining unused portion can be carried over to the surviving spouse to be used in that estate. There are numerous limitations and weaknesses in relying on portability, and we suggest that clients continue to have Wills that leave property to surviving spouses in trust(s), generally a combination of a Credit Shelter Trust and a QTIP Marital Trust.
Life insurance trusts are very common in many estate plans. It almost always seems to be a good idea to get life insurance out of estates now. As we get older, our clients acquire a lot of insurance for estate liquidity purposes. If we maintain insurability, it is always good to have these policies reviewed to make sure that you are allocating resources as prudently as possible. There may be situations where it would be prudent to prepay premiums.
Another method of reducing an otherwise taxable estate would be to consider a Roth conversion of a traditional IRA as a technique to get taxes out of a taxable estate, in a situation that would otherwise involve an asset (the traditional IRA) that will be subject to both income taxes and estate taxes upon the death of the owner.
Clients with more modest estates need to combine estate planning with Medicaid planning. What can be done to protect assets if one of the spouses has to go into a nursing home? First of all, both spouses should have a current Health Care Directive as a necessary part of their estate planning documents. Considerations should be made to move investments to the name of the healthier spouse. The healthier spouse’s Will can create a special needs trust in the event that he or she predeceases the spouse with health and living assistance concerns.
A part of estate planning should consider the need for long term care insurance. The sweet spot to acquire long term care insurance seems to be when a couple is still in their 50’s.
The couple can consider a lifetime QTIP Marital Trust. This would combine estate tax planning with Medicaid planning. The lifetime QTIP is a method to protect the home in the event of Medicaid stepping in. We also have a technique referred to as an Irrevocable Income Only Trust (IIOT) which can be established to start the five year look back rule for Medicaid. Finally, once a spouse is moved to a nursing home, continued planning should be done for the independent spouse.
Besides Wills that create trusts for the surviving spouse and lifetime trusts for descendants, the Irrevocable Life Insurance Trust to remove life insurance proceeds from anyone’s taxable estate, the Health Care Directive, and any “special” trusts created for Medicaid planning, everyone should have a comprehensive General Power of Attorney. These power of attorney forms should be “durable” so that the document remains in force after disability or incapacity. In Georgia, these documents can be drafted so that they do not spring into effect until they are needed.
Remember that the more you plan, the more you save and the smoother the probate process will be for your loved ones. The old adage is that “…we haven’t got an estate tax, what we have is, you pay an estate tax if you want to; if you don’t want to, you don’t have to.”
If you have any questions about estate planning, please contact Hoffman & Associates at (404) 255-7400.
December 2010 turned out to be an exciting month for estate and gift tax laws. On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “Act”). The Act sets forth an exemption amount of $5,000,000 for federal gift, estate and generation skipping transfer taxes for years 2011 and 2012. In addition, the Act sets the top tax rate at 35 percent. The Act further provides for portability between spouses in 2011 and 2012 to utilize the unused estate tax exemption amount of the first to die of the spouses if the second spouse dies before 2013.
Since this Act is only good for 2011 and 2012, if Congress fails to act to extend this current law, the federal gift, estate and generation skipping transfer tax exemption amount reverts back to $1,000,000 and the top tax rate of 55 percent returns.
With this two year Act, there are many planning opportunities. Obviously, individuals can gift up to $5,000,000 without any federal gift taxes. Gifts can be made to a grantor trust (which means the trust income is attributable to the grantor rather than the trust) that allows the gift to grow without incurring income taxes. In the alternative, an individual can purchase a significant amount of life insurance coverage inside a life insurance trust utilizing the increased gifting exemption of $5,000,000 which can then pass free of probate, income and estate taxes to future generation.
Because the Act is only temporary, it is a good idea to review your current estate planning documents to make sure it stills accomplishes the goal desired.
Many of our clients gift life insurance premiums to their life insurance trusts on an annual basis. Prior to passage of the 2010 Tax Relief Act, there was uncertainty and risk around these gifts with regard to allocation of generation skipping transfer tax exemption. As a result, our advice to clients was to treat the money given to the life insurance trust in 2010 as a loan. However, with the passage of the 2010 Tax Relief Act on December 17, 2010, it now appears that you can allocate generation skipping transfer tax exemption to gifts to pay premiums made to life insurance trusts. Therefore, as of this week, we do not recommend clients treat the money as loans to the life insurance trust. Instead, we recommend treating those transfers as gifts as usual and applying the generation skipping transfer tax exemption on a timely filed 2010 Gift Tax Return, which must be filed no later than September 17, 2011. This negates the necessity of all the paperwork associated with documenting a loan, such as the promissory note.