Archive for the ‘net investment income’ Tag

New Tax Impacts for Trusts with Capital Gains – Part II

Originally published in the Cedar Street Times

November 15, 2013

Two weeks ago I laid the groundwork of some of the basics on revocable and irrevocable trusts in order to start discussing new implications due to law changes in 2013.  Revocable trusts such as the common revocable living trust most people use for estate planning is disregarded for tax purposes as separate from the owner – in other words all of the income generated by its assets gets reported on your personal 1040 tax return.  Irrevocable trusts, such as a bypass trust commonly used in estate planning, or a gifting trust, are treated as separate tax paying entities, get their own taxpayer identification number, and file their own tax returns.

In early 2013 new laws were passed that increased the personal income tax rates from 35 percent to 39.6 percent on people in the highest tax bracket ($400,000 filing single or $450,000 married filing joint).  It also raised the capital gains rate to 20 percent for these same people (up from 15 percent).  In addition, a new 3.8 percent Medicare surtax is assessed on net investment income (think interest, dividends, capital gains, among others) for people making over $200,000 single or $250,000 filing joint.  Most people do not make $450,000 or even $250,000 a year, so this seems innocuous to many.

However, many people making less than these thresholds do have irrevocable trusts – most commonly after a spouse has passed away.  The problem with irrevocable trusts is that the thresholds to be impacted are so much lower.  Once your trust has just $11,950 (2013) of income, you have hit the top bracket and will be subject to the 39.6 percent income tax rate, 20 percent capital gains rate, and the 3.8 percent Medicare surcharge!  One stock sale could easily put you in the top bracket!  This effectively means an 8.8 percent tax increase on capital gains and 4.6 percent to 8.4 percent increase on other types of income.  That is a big hit every year, and will be something new to battle.

If you can avoid having the income taxed to the trust, and instead have it distributed out and taxed to the beneficiaries, you can probably save a chunk of taxes since it will be taxed at the lower rates on the beneficiary tax returns – assuming your individual beneficiaries are not in the top tax bracket!

Whether or not you have discretion or are required to distribute income to beneficiaries is defined in your trust document.  Even the very definition of “income” itself, for trust accounting purposes, is governed by your trust document primarily and the state’s principal and income act, secondarily.  The proper allocation of income and expenses to trust accounting income or principal is very important to beneficiaries (whether they realize it or not), since trust accounting income generally goes to one beneficiary, and the principal often goes to a different beneficiary down the road…so it determines the amount the beneficiaries receive.  Many common irrevocable trusts are written to require the distribution of trust accounting income each year to the current beneficiaries with rights to dip into principal as needed to maintain an ascertainable standard of living.  Upon death, the remaining principal goes to the remainder beneficiaries.

The California Uniform Principal and Income Act does not define capital gains as income, but as a principal transaction – basically an asset changing form – for instance from real estate to cash.  I hardly ever see trusts that even mention capital gains, much less defining it as a part of income.  In the absence of trust language, the principal and income act governs, therefore many trusts in California are not permitted to distribute capital gains to the beneficiaries.

It is amazing to me how many trust tax returns I have seen over the years that violate this – often because the preparer does not really understand trust taxation rules.  I have even run into cases where the prior preparer has never even asked for the trust document, and thus relies on the default settings in their tax software in conjunction with “the way we’ve always done it” to govern!  This would be analogous to creating a detailed shopping list and asking your neighbors to go shopping for you; in lieu of taking your list, they go on the internet and print out a list of common things people buy, and then supplement it with things they have bought for other neighbors in the past! Chances are pretty good; you will not get what you need!  Enforcement of correct trust income tax preparation comes much more often by threats of lawsuit against the trustee than by IRS audit. Keep in mind the remainder beneficiary’s attorney would be happy to sue the trustee for shorting his client’s share by not following the terms of the trust.

In two weeks we will conclude our discussion.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

American Taxpayer Relief Act of 2012

Originally published in the Cedar Street Times

January 11, 2013

The American Taxpayer Relief Act of 2012 was signed into law January 2, 2013.  There was lots in the bill, but I am going to hit on a few that are notable and others that having meaning to a lot of people.  I think making the Alternative Minimum Tax patch permanent and indexed for inflation was a huge victory for many taxpayers.  That patch has been kicked down the road for years.  The indexing will certainly alleviate concerns of a similar problem down the road.  Many middle class people do not realize they were on the cusp of paying thousands of dollars more on their 2012 tax returns due in April without this fix.

The estate tax exemption being set permanently at $5 million and also indexed for inflation is huge, especially for Californians that own property.  In a lot of ways, this simplifies estate planning for most individuals and will bring into question the need of the typical A-B split for many people that currently have it.  Having a B trust, or bypass trust, would require additional tax work in the future, so the ability to eliminate it, could be worth the cost of amending your trust.  Family dynamics may of course still dictate a B trust is prudent.

Various other temporary provisions we have been enjoying that were made permanent included marriage penalty relief for joint filers, better rules for student loan interest deductions and dependent care credit rules.

Quite a few things were extended but not made permanent.  A big one was extending the exclusion from income of cancelled debt on personal residences for another year.  This could be a lifesaver for those still struggling with mortgages that are “underwater.”  Deductions for grade school teacher expenses and an above-the-line deduction for qualified tuition and related expenses were other items extended through 2013.  More important than the deduction for tuition was the extension of the American opportunity tax credit through 2018 which saves taxpayers up to $2,500 each year as a result of education costs.  Enhanced provisions of the child tax credit were also extended through 2018.

Small businesses have had the luxury of writing off high dollar amounts of many capital asset purchases through code section 179.  This was slated to return to $25,000, but has been extended through 2013 at $500,000.  Bonus depreciation and accelerated expensing of qualified leasehold, restaurant and retail improvements on a 15 year schedule instead of returning to a 39.5 year schedule was also extended.

Bush-era tax rates and capital gains rates have been retained for everyone but the wealthy.  For people making over $400,000, their marginal bracket rose from 35% to 39.6%, and their capital gains tax went from 15% to 20%.  There is also a new 3.8% medicare tax on investment income for people generally making over $200,000 and a new hospital insurance tax of .9% for people generally making over $200,000.  Itemized deduction phaseouts have also returned for high income earners.

Everyday wage earners will be negatively impacted by the return of a 6.2% tax for Social Security rather than 4.2% tax we have had for the past two years, as they will see two percent less in their paychecks as a result.  Another negative impact for people with high uninsured medical expenses, is that the threshold for medical itemized deductions has moved from 7.5% of your adjusted gross income to 10%.  Individuals 65 and up will still enjoy the 7.5% rate for another three years.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Your Future Tax Return: Romney Versus Obama

Originally published in the Cedar Street Times

November 2, 2012

If tax positions would sway your Tuesday vote, here is what Obama and Romney would like to see.  Keep in mind, however, you don’t always get what you want!

Tax brackets: Romney reduce to 80% of current levels. Obama keep the same as 2012 except allow top bracket to split into two higher brackets like pre-2001. (Romney, Current 2012 Rates, Obama, 2013 rates if no congressional action ) (8%, 10%, 10%, 15%), (12%, 15%, 15%, 15%), (20%, 25%, 25%, 28%), (22.4%, 28%, 28%, 31%), (26.4%, 33%, 33%, 36%), (28%, 35%, 36% and 39.6%, 39.6%)

Capital gains, interest, dividends: Romney reduce tax rate to zero for AGI below $200K.  15% max if AGI above $200K. Obama increase long-term capital gains rate to 20% max and up to 39.6% on dividends – leave interest taxed at ordinary bracket rates.

2013 3.8% Medicare surtax on net investment income and existing 0.9% medicare surtax for married filers over $250K AGI and others over $200K: Romney repeal.  Obama keep.

Itemized deductions: Romney cap itemized deductions (maybe $17,000-$50,000 cap) and maybe eliminate completely for high income.  Obama reduce your itemized deductions by 3% of your AGI in excess of $250K married, $225K HOH, $200K single, and $125K MFS (up to 80% reduction of itemized deductions) and limit the effective tax savings to 28% even if you are in a higher bracket.

Income exclusions: Romney keep as is. Obama cap the effective tax savings to 28% on exclusions from income for contributions to retirement plans,  health insurance premiums paid by employers, employees, or self-employed taxpayers, moving expenses, student loan interest and certain education expenses, contributions to HSAs and Archer MSAs, tax-exempt state and local bond interest, certain business deductions for employees, and domestic production activities deduction.

AMT: Romney repeal. Obama keep but set exclusion to current levels and index for inflation.

2009 expanded Child Tax Credit, increased Earned Income Credit, and American Opportunity Credit: Romney – Allow to expire as scheduled 12/31/12.  Obama – Make permanent.

Buffett Rule: Romney “Not gonna do it.” Obama households making over $1 million should not pay a smaller percentage of tax than middle income families.  This is accomplished by raising the rates on capital gains and dividends as discussed earlier.

Temporary two percent FICA cut you have been enjoying in 2011 and 2012: Both candidates favor allowing to expire at 12/31/12.

Estate tax: Romney repeal.  Obama set at $3.5 million and index for inflation with top rate of 45% on excess.

Top corporate tax rates: Romney 25%. Obama – keep at 35% for 2013 but maybe reduce to 28% in the future.

Corporate international tax: Romney don’t tax U.S. companies on income earned in foreign countries. Obama discourage income shifting to foreign countries.

Corporate tax preferences: Romney extend section 179 expensing another year, create temporary tax credit, expand research and experimentation credit. Obama increase domestic manufacturing incentives, impose additional fees on insurance and financial industries, reduce fossil fuel preferences.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.