2013 Year End Notes, Part 2: Year End Tax Planning / Looking Ahead to 2014: What to Do Now About Higher Income Taxes

1.  Expiration of top 35% income tax rate and reset to 39.6% in 2013;
2.  Expiration of top 15% rate on long-term capital gains and reset to 20%, plus the 3.8% investment tax under the Affordable Care Act (“Obamacare”), for a top capital gains tax rate of 23.8%;
3.  Expiration of top 15% rate on qualified dividends and jump to 39.6%, plus the 3.8% investment tax under the Affordable Care Act, for a top dividend tax rate of 43.4%;
4.  The gift and estate tax rate increased from 35% to 40%.

In addition, beginning in 2013, a 3.8% tax on net investment income was imposed on joint filers with an AGI greater than $250,000 ($200,000 for single filers) pursuant to the Affordable Care Act.   This additional 3.8% tax is in addition to the already heightened rate that will apply and will be assessed on taxable interest, dividends, rents, some annuities and capital gains including on the sale of real estate.

Congress may also amend other tax laws to eliminate some favorable tax planning strategies.  Clients are therefore advised to engage in tax planning now, in order to have the benefit of “grandfathering” current beneficial tax strategies before additional changes to the tax law.   We can help explain tax changes, how they may effect your specific situation, and how to legally minimize your taxes.

There are various steps that taxpayers should consider now for effective tax minimization:

1.  Avoid capital gains tax via a Charitable Remainder Trust or via international tax planning strategies (e.g.  tax advantaged foreign annuities and foreign private placement life insurance).

2.  Convert IRAs, 401(k)s and other retirement plans to Charitable Remainder Unitrust IRAs before the government taxes them.

3.  Engage in income tax planning via tax-compliant strategies that take advantage of favorable reciprocal tax treaties.

4.  Consider a Dynasty Trust.  Such a trust allows the preservation of assets for one’s immediate and remote descendants, along with offering asset protection from creditors, as well as delay of the estate tax bite for many generations.   The trust can distribute income to beneficiaries (who will pay income tax on these distributions of income), but principal is preserved, asset-protected and grows tax-free.  The estate tax would potentially apply at the eventual distribution of principal, many generations down the line, but your descendants would have many years to plan around the estate tax.

5.  Consider a Charitable Remainder Trust.  Contributing appreciated assets, such as stock, family businesses and real estate to a Charitable Remainder Trust is a good way to avoid the increased capital gains tax.  You and your beneficiaries can enjoy distributions from the trust at very low tax-favored rates, and at the end of the trust term, a remainder equal to ten percent of the original contribution to the trust will go to a qualified charity.^[1]   You will receive an additional tax benefit: a deduction equal to the present value of the remainder that will be left to charity.   The benefits: a low-tax income stream for you and your beneficiaries, philanthropy of your choice, a charitable deduction and significant capital gains tax minimization.

6.  It is also possible to minimize the tax on appreciated assets by exchanging such assets in return for a foreign annuity policy.  Capital gains within the annuity policy would not be taxable.   Annuity payments can be deferred until retirement or advanced age, at which point tax would be due on the income component of the annuity payments.   Moreover, the annuity policy and the assets within the policy would be completely asset-protected from future creditors.   For complete tax elimination, a foreign life insurance policy can be incorporated, which would allow one to borrow against the cash value of the policy, completely free of taxation (the amounts borrowed, rather than having to be repaid, would be deducted from the ultimate death benefit).  Such tax strategies involving foreign annuities and foreign life insurance offer the most advanced asset protection from civil creditors, as well as significant tax minimization or even tax elimination.

Of course, gifting and leveraged gifting are very advantageous ways of lowering one’s tax base.  See: 2013 Year-End Notes, Part 1: Historic Opportunity to Avoid Estate Tax on $10.5 Million of Assets.  In addition, consider gifting appreciated investment assets to charity.  If you’ve owned the appreciated investment for longer than one year, you may be able to deduct the full market value and avoid tax on the appreciation.

It should be noted that tax strategies such as those above were utilized to save significant amounts of taxes in several recent highly publicized transactions, including the 2013 initial public offering (IPO) of Twitter, the 2012 IPO of Facebook, and the sale of Lucasfilm to Disney in 2012.   The strategies discussed herein are available to everyone with appreciated assets and estates of all values.

Please contact us to discuss any of these tax minimization strategies, in light of the new tax regime.

For additional year-end strategies, please see 2013 Year End Notes, Part 1: Historic Opportunity to Avoid Estate Tax on $10.5 Million of Assets.