By NANCY O. KUHN & STEVEN A. SIGSBURY
Circle Dec. 31, 2012 on your calendar. Not only is it New Year’s Eve, but it is also the last date that a multitude of current tax rates, credits and exemptions will be in effect, both at the state and federal levels. The question that should be on many people’s minds heading into this election season is: What action needs to be taken this year, and what can wait until later?
This article presents a short rundown of the various tax law changes that are slated to take effect as of Jan. 1, 2013, and suggests a few planning ideas that individual taxpayers may wish to consider in light of these changes.
Unless Congress and the president act, individual income tax rates are scheduled to rise in 2013. This includes rates on capital gains and qualified dividends. Higher income earners will also see the addition of a new 3.8 percent Medicare surtax, created by the Affordable Care Act.
So what should you do? Here are some ideas that may be helpful:
• Convert Traditional IRAs to Roth IRAs, which will allow you to pay ordinary income tax on the converted amount using 2012 rates, and exclude future growth and distributions from additional income tax.
• Plan to accelerate income this year, so that it will be taxed at the current income tax rates. Accelerating income this year will also prevent it from being subject to the 0.9 percent wage surtax.
• Cash in appreciated stocks this year so that you can trigger recognition of capital gain at the favorable 15 percent rate and not subject the investment’s appreciation to the 3.8 percent Medicare surtax next year. (This income would be subject to the surtax only if the $200,000/250,000 taxing threshold is met.)
• Consider incurring and deducting medical and dental expenses (including insurance premiums). The threshold to deduct medical and dental expenses for itemizers is scheduled to increase from 7.5 percent to 10 percent of adjusted gross income in 2013.
Higher income earners (approximately $200,000+) will again be subject to the phase-out of itemized deductions in 2013. The deductions for taxes, interest (except investment interest), charitable contributions, employee job expenses and “miscellaneous” itemized deductions (excluding gambling and casualty or theft losses), will be reduced. The thresholds to trigger the phase out have not been announced, but will be indexed for inflation based on the 2009 threshold of $166,800. If you may trigger this limitation in 2013, consider incurring 2013 expenses that you normally itemize in 2012, so that you may receive a full deduction for the expense. For example, give generously to your favorite charities in 2012 to maximize the value of the charitable deduction.
In addition to the long list of expiring income tax provisions, the current estate, gift, and generation-skipping transfer (“GST”) tax rates and exemptions are also scheduled to “roll back” to their 2001 levels. The exact figures will be tied to inflation, based on levels prior to the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001, also known as the “Bush Tax Cuts.”
The practical effect of this roll back is staggering. The past few years have given individuals the unprecedented ability to transfer, free of gift or estate taxes, up to $5,120,000 of wealth. Unless Congress acts to extend the current law, that figure will drop to $1 million on Jan. 1, 2013. Transfers above that amount will trigger gift or estate tax at a 55% rate in 2013.
With these scheduled changes, which will increase rates and decrease exemptions, individuals should consider estate planning techniques to utilize the current $5,120,000 exemptions and the favorable tax rate available to them this year. Planning techniques that are attractive include:
• Making large gifts in 2012 to use some, or all, of your $5,120,000 gift tax exemption. If you wait, such property may be subject to the 55 percent tax rate.
• Gifting to irrevocable trusts to benefit children and grandchildren. This will utilize your gift tax exemption, and the appreciation on the gift will not be subject to estate tax at your death.
• Gifting to a grantor retained annuity trust (“GRAT”), which will utilize your gift tax exemption and take advantage of the current low interest rates. Appreciation above the trust’s stated interest rate will remain in the trust after the annuity term ends, free of gift tax.
• Allocating your available GST exemption to an irrevocable trust, which will allow you to exempt up to $5 million of trust property for your beneficiaries.
The upcoming election may break the logjam that is currently preventing tax reform. However, given the number of tax changes that will be implemented by default on Jan. 1, 2013, it is strongly recommended that individuals accomplish any tax-related planning well before the end of the year, while considering that current rates could continue, decline, or increase in 2013. More likely a mixture of rate changes will occur, and so all 2012 tax planning should consider all scenarios.
The contents of this article are intended for general informational purposes only and should not be considered legal advice.
This is part of a series of monthly articles by Jackson & Campbell on legal issues of interest to the LBGT community. Celebrating its 125th anniversary, Jackson & Campbell is a full-service law firm based in Washington with offices in Maryland and Virginia. If you have questions regarding this article, contact Nancy O. Kuhn at 202-457-1621 or firstname.lastname@example.org or Steven A. Sigsbury at 202-457-1627 or SSigsbury@jackscamp.com. If you have questions regarding our firm, please contact Don Uttrich, who chairs our Diversity Committee, at 202-457-4266 or email@example.com.