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Immediate 2012 Tax Planning Opportunities for Individuals

Bob Keebler discusses three opportunities individuals can take advantage of while we wait for final resolution on the "fiscal cliff." Bob discusses gain harvesting to avoid the increase in the capital gains, Roth conversions to avoid the increase in income tax rate and the potential to take advantage of the loss of state income tax deductions in the future, and finally funding dynasty trusts before a new federal law could come into effect. Visit aicpa.org/PFP/YearEnd for free resources to help you get financial plans in place for your clients now.

3 Immediate 2012 Tax Planning Opportunities for Individuals

Robert S. Keebler, CPA, MST, DEP, Partner, Keebler & Associates, LLP. Bob is a 2007 recipient of the prestigious Distinguished Estate Planners award from the National Association of Estate Planning counsels. From 2003 to 2006, Bob was named by CPA Magazine as one of the top 100 most influential practitioners in the United States. He is the past Editor-in-Chief of CCH's magazine, Journal of Retirement Planning and a member of CCH's Financial and Estate Planning Advisory Board. His practice includes family wealth transfer and preservation planning, charitable giving, retirement distribution planning, and estate administration.  

This audio webcast was originally recorded Dec. 7, 2012.

Transcript:

Good day. On behalf of the PFP Division of the American Institute of Certified Public Accountants, this is Bob Keebler with three immediate tax-planning opportunities for 2012. Today is Friday, December 7, 2012 and negotiations in Washington continue in solving our fiscal crisis.

The three opportunities I would like to talk about today are gain harvesting to avoid the increase in the capital gains, Roth conversions to avoid the increase in income tax rate and potentially to take advantage of the loss of state income tax deductions in the future, and finally funding dynasty trusts before a new federal law could come into effect.

Let's look at gain harvesting first. Today the capital gain rate is 15%. In 2013, the capital gain rate is expected to increase to 20% if we go over the fiscal cliff. Further, the 3.8% healthcare surtax will also come into play. Accordingly, you're looking at a delta of 8.8%, 23.8 minus 15. If we lose some of our itemized deductions for state income taxes, this becomes even more complex, perhaps a rate in the 27% range. 

Accordingly, many of your clients should evaluate harvesting gains in 2012. Over the last year we have developed a computer model to analyze this, and in the initial years the return on investment for harvesting gains is over 50% in year 1 and over 25% in year 2. It all depends on the dynamics of eventual rate increases. 

The same concepts also exist with regard to accrued interest income. If your clients have bond portfolios, it may be very wise to sell bonds towards the end of December 2012, accelerating that income into 2012, thus avoiding any increase in income tax rates and avoiding the 3.8% healthcare surtax.

Along the same lines, Roth conversion should also be reviewed, but Roth conversions, unlike gain harvesting or accelerated income, give you an opportunity to turn back the clock. Remember, the most important thing about Roth conversions is the ability to re-characterize, to go back and undo your conversion.

If you have a client, perhaps in California, who is worried about losing their state income tax deduction, let's analyze the efficacy of a Roth conversion. Today, if your client converts the Roth IRA, the tax rate will be 35% federal plus a California rate less the benefit of the federal income tax deduction for the California tax. Simply put, let's assume the California tax rate is 10%. After the federal income tax deduction, that's actually a 6.5 rate, 10 minus the 35% tax benefit, coming to a total tax rate of 41.5%. 

In the alternative we go to a 39.6% federal tax rate and we add to that a pure California rate of 10% without the federal benefit. We're now at a rate of 49.6%, a delta of 8.1% from where we stand today. This is important. That type of rate swing in most instances will support a Roth conversion, even a very large Roth conversion. 

Remember though you do not have to be right today. You do not have to be right on whether tax rates go up. You do not have to be right on whether we lose some of our itemized deductions. You do not have to be right on what the economy does. You have until October 15, 2013, over 10 months from now, to determine whether a Roth conversion was appropriate for your clients. The right of re-characterization is paramount here and should be the number one tool in your toolbox. 

Finally, with regard to estate planning, we are all very much aware that the $5,120,000 exemption is currently in danger. If we go over the fiscal cliff, the exemption returns to $1 million. There is nothing novel about that, and many of you have been helping clients for the last six/eight months with this planning. However, what's very important right now is to recognize in President Obama's proposals, one of the proposals would create a federal rule against perpetuities limiting the benefits of a dynasty trust in a state like Delaware, South Dakota, Alaska. 

States like Florida and Nevada allow a 360-year trust. Trusts would only be allowed to go for approximately 90 years. Now this -- this creates an interesting complexity with regard to existing dynasty trusts that your clients have that are already in place. Let's say your client has a life insurance trust and you have been very diligent with filing gift tax returns to allocate GST exemption to that trust, knowing that that trust will go on for many, many generations. 

If the proposal of the administration were to come true, the trust would be limited to 90 years. But the life insurance trusts needs further capital. Each year there are insurance premiums that need to be made, plain and simple. If this comes to be, and as we watch the law evolve in the next three to four weeks, if this all comes to fruition and we lose the privilege of creating dynasty trusts, what you're going to want to do is prefund those trusts to the extent possible and allocate GST exemption, locking in the benefit of this for future generations.

On behalf of the PFP Division of the American Institute of Certified Public Accountants, this has been Bob Keebler with three tax planning ideas for December, 2012. 

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