Year-End Financial and Tax Planning Strategies [PODCAST]
In the third webcast in the AICPA Insights Live webcast series, Beth Gamel, CPA/PFS, Robert S. Keebler, CPA, Ted Sarenski, CPA/PFS and Scott Sprinkle, CPA/PFS, CGMA came together to discuss year-end financial and tax planning strategies, specifically to address the American Taxpayer Relief Act and the Net Investment Income Tax. Below you can find an audio recording from the webcast, as well as the accompanying presentation. (Email subscribers can listen to the podcast and see the presentation on our website.) Be sure to explore the other webcasts in the AICPA Insights Live webcast series.
MODERATOR: Let's get to today's webcast on year-end tax-planning strategies. For today's event, we're thrilled to be joined by a panel of the nation's leading financial planning experts to discuss year-end tax-planning strategies for your consideration.
Beth Gamel cofounded Pillar Financial Advisors in 1986, has been helping wealthy individuals evaluate, coordinate and implement sophisticated investment, estate, income tax and charitable giving strategies. She served on the executive committee of AICPA's Personal Financial Planning Division and completed two terms on the AICPA's national CPA Financial Literacy Commission. Beth currently sits on the Schwab Advisory Board.
Robert Keebler is a partner with Keebler & Associates, LLP. He has been named by CPA Magazine as one of the top 100 most influential practitioners in the United States and one of the top 40 tax advisors to know during a recession. His practice includes family wealth transfer and preservation planning, charitable giving, retirement distribution planning and estate administration.
Ted Sarenski has more than thirty years' experience as a CPA and over twenty years as a financial planner with his firm Blue Ocean, LLC, delivering wealth management services to Central New York. His extensive experience in individual taxation and estate planning bring a dimension to wealth management not found in most other asset management firms at the local level. Ted is recognized locally and nationally as an expert in providing financial planning advice.
Last but certainly not least, Scott Sprinkle is a cofounder and managing member of Sprinkle & Associates LLC and Sprinkle Financial Consultants LLC. He has more than twenty years of experience serving high net worth individuals and family offices. His areas of expertise include investment consultation and management, family office services, estate and wealth planning, income tax planning, retirement planning, individual cash-flow management, insurance and survivors' needs, college and dependent funding.
Thank you all for joining us today. Let's get started.
TED SARENSKI, CPA: Thank you for that intro and welcome, everyone. Just like to say that today's presentation is brought to you by the PFP section of AICPA. The AICPA's PFP section gives us information, resources, advocacy and guidance for CPAs who specialize in providing estate, tax, retirement, risk management and investment planning advice to individuals and their closely-held entities.
Today, what we'd like to cover in our agenda is year-end planning strategies for ATRA, the American Tax Relief Act, the net investment income tax that a lot of folks should be worried about this year, especially with the market that we've had, things going up. And we will be able to discuss other planning strategies that you want to consider for your clients before December 31: tax, estate, investment, retirement, insurance and healthcare reform. So that is what we're going to cover today and let's get started with that.
This slide was prepared by Michael Kitces; he's Director of Research at Pinnacle Investments. And what I would suggest, to anyone who does prepare taxes or anyone who has anything to do with any client asking them any tax questions, show them this chart. Copy it off, laminate it. This chart is fabulous for showing the complexity of the new law in terms of when do various things come into play.
When do various income tax rates come into play is something we might have always looked at, but we've got different levels for different long-term capital gain rates, different levels for when the 3.8% Medicare tax kicks in, a different level for a 0.9 extra tax for those over 200 or 250,000. Phaseouts of itemized deductions, phaseout of personal exemption, AMT exemption phaseouts. All these at different levels.
And this chart, I think, if you showed your clients, this is what planning is involved. This is where you really need to look and say, "We can't just sit there with a pencil and paper and say, 'Here's what your taxes are going to be.' It's very, very complicated." I don't think clients really appreciate all the work that's going on behind tax returns these days, especially -- even just the last couple years, how difficult even Schedule D became with some of the attachments.
So, again, this would be a great chart to show anyone who says, "Why does it take you so long to do a tax projection for me?" Even if you're using a program like BNA, you want to be able to know what's behind it; this chart's a great chart to help you with that.
You've been hearing a lot about healthcare reform?
Let me go back just a little bit, because I skipped over a comparison of rates and I'd like to compare the rates between 2012 and 2013. This is where planning for 2013 prior to December 31 is going to be extremely important. Bob Keebler, who's on our call, produced this chart for us and it shows the percentage increase, especially with higher-income people, how much their taxes are going up this year in the ordinary rates, capital gain rates -- payroll taxes went up for everyone. We all had an increase at the beginning of the year. The new Medicare tax, payroll surtax and Beth'll be talking about estate taxes and the estate tax rate going up.
So another chart you could talk to people about and say, "We've got a lot of higher taxes this year. If you took the same income from 2012 and applied it to 2013, you're going to be in for quite a surprise." And that's something you need to show them now, not in January or February, when now you might be able to do something with it.
The government is open. We -- we're -- had the debt-ceiling issue and now that is suspended until February 7th. Now, Congress is getting together to issue a report no later than December 13. There was a piece in The Wall Street Journal this morning talking about how both sides, Democrat and Republican, are not expecting too much to come out of that conference, not a lot of large or big changes to maybe make a difference in balancing the budget. So don't expect too much from that, but then, on January 15, of course, we've got to worry about funding of the government.
So we got past that here in October, we'll be addressing it again in January and February, but, certainly, from a tax standpoint, we've got to make sure people are in shape. Going to have a couple extra weeks, I guess, to prepare those taxes, since IRS was part of that shutdown as well.
Threatening US credit downgrade. Of course, you saw things in china making comments that maybe the US dollar shouldn't be the standard any more.
Did the market react? Yes, the market reacted both ways. It reacted down and up, but, if you look back just a couple years, it didn't react as greatly as it did when we were just past the financial crisis and Europe was going up and down, in terms of were they going to be okay.
Markets are concerned about this, certainly they're concerned about credit ratings, but they're -- I do believe, though, they're more in tune with "How are companies doing? What are the fundamentals of the stocks or bonds or the companies behind those stocks and bonds that's driving the market?" They all -- the market always reacts to things that are going on in the world, but, gladfully, they're not reacting too bad with things that are going on.
We've heard a lot about healthcare reform and how the system -- the computer system is not working, but the 2014 rules have not been suspended for those who don't have insurance for individuals and for small companies from 2 to 50 employees. So small business needs to pay attention to this. They have to sign up by November 30 -- the small business needs to -- in order for their employees to have time to sign up by December 15 to have coverage start January 1st of 2014.
It's important to educate your clients now. Again, individuals who haven't had insurance, individuals who've had individual policies or small businesses 2-50. If you've got large businesses, they were deferred to 2015. It's still out there, a lot of people clamoring, a lot of people asking for suspension of this for individuals as well. But, as far as we know, it's a go-forward on the healthcare reform for, again, individuals, small businesses.
What we're going to do now is turn this over to Bob Keebler to talk a little bit here about the Defense of Marriage Act. Bob?
ROBERT S. KEEBLER, CPA: Thank you, Ted. And let's go back one more slide to Slide 10, please.
With DOMA, basically what's happened is the US Supreme Court has said that same-sex spouses are married for all federal tax purposes. Between what the Supreme Court said and what the IRS came out -- which we'll talk about in a second -- that's where we are.
You're immediately -- your immediate concern, are there estate tax returns that should be amended. Should you be going back to get portability on estate tax returns for 2011 and 2012? Should we be looking at IRA rollovers for these couples? What about gift tax returns? Were they filed correctly? Do we need to amend those returns? And can we go back and gift-split, even if we already filed a return without gift-splitting? Can we try to do that, basically taking the position that the IRS cannot enjoin us from doing something like that and we -- there was detrimental reliance on the IRS position at that moment.
So, basically, there's a lot of information under the aicpa.org/pfp, "For More Information," but this is something we're all going to work very hard at.
Now, let's go to the next page and talk about Revenue Ruling 2013-17. Basically, if a couple was legally married in a jurisdiction that recognize same-sex marriages as legal and valid, then same-sex spouses are married for all federal tax purposes. So you might even have a couple that was married in Canada and they're now living -- let's just say North Dakota. North Dakota does not recognize same-sex marriage, but federal law for this purpose, for the purposes of the US Tax Code, will recognize same-sex marriage; that's very important.
Now, filing status. Basically, where we are, filing status-wise, if you are married in a state that recognizes same-sex marriage -- or, for example, married in Canada like the Windsors were, the couple that created this whole case in the first place -- then you are married for federal purposes, whether you're living in same-sex marriage state or a traditional marriage state.
Basically, though, after the 16th of September, same-sex spouses must use married filing separate or married filing joint; you can't file single any more. Before that, you could choose. The government is not going to go back and make anyone that was filing single go back and file married where they might pay some more tax. So that's a good thing, that that's not happening.
Okay, now, let's jump up to the next page.
Now, what we're talking about here is we're going to jump into income tax planning. So one more -- thank you. Basically, here's what we have. Michael Kitces' chart said it all. We are in a five-dimensional tax system. You're saying, "Where do you get five dimensions?" Regular tax, AMT, the 3.8% surtax and then the supertaxes that are being imposed when you have income of over $450,000 for a married couple. Those supertaxes include a 20% capital gain rate and a 39.6% regular income tax rate. So we have to get our mind around all this.
We actually have seven regular tax brackets now and three capital gains bracket -- brackets. And the complexity here, as shown by Michael's chart, is -- it's exponential, not linear. Your job, my job has become incredibly more complex. The profession needs new tools, which we'll talk about a little bit later to react to this.
As I started looking at clients' materials, we started -- we represent people with large IRAs. And when they hit their RMD, everything -- their income jumps way up and we have many people here in Northeast Wisconsin that -- retired physicians, retired engineers, retired lawyers, these big IRAs. But they do not -- they do not tap into their IRAs until they're forced to; they can live off other assets.
So what happens is their tax rate's going to jump and so we believe we have to look at things maybe for those clients and for many of our clients over a ten- to fifteen-year perspective, not just rather a rather myopic two- or three-year per- -- like we've done in the past. But the analysis is going to be much more in depth.
And so a lot of what we've done is we've worked very hard to build new software where we can actually have graphic analysis, which leads you right to the point where you can quickly see where their brackets are and what you should be doing. So we're working hard on that; there'll be more to come, but that's a challenge.
Now, we have a 15 and 25 -- 15 -- 10, 15, 25 and 28% rates, okay? We know we have the 33 and 35, but we also have, you know, basically the 39.6, when your income goes over the threshold which were on the prior slide.
Now, on this slide, we talk about the capital gains rate. On the capital gains side of things, what we are up against is there is a 20% capital gains rate when your income goes above those thresholds. Virtually no one, other than people selling a closely-held business, will pay the -- a closely-held S corporation or C corp -- will pay the 23 -- or will pay the 20%; they're going to be paying 23.8, because you have to add in that 3.8% surtax.
And where this is going to get very dynamic, you represent a couple, they were married in 1959, shortly after their wedding, they bought forty acres of land on the edge of town. And now they're selling that forty acres of land for $75,000 an acre, call it around $3,000,000. They're going to have a $3,000,000 capital gain, give or take, and that is going to cause them to have to pay tax at 23.8. Now, if they were to sell that over time, slowly, like on an installment sale or break it up and sell it, then they might be able to get their rates down to 15% or even a lower rate, a 0% rate, when they're in that -- in the smallest bracket.
Now, under the law, qualified dividend treatment was also made permanent, which is a good thing and we'll talk about that when you look at a chart I put together.
Now, basically, on the next chart, we talk about something called PEP and Pease. PEP and Pease on Chart -- on Slide 15 talk about when your exemptions phase out, okay? So -- now what's happening here is, when my income goes over -- when my wife's and my income goes over 300,000, we start to lose both our itemized deductions and we start to lose our exemptions, okay? And there's a little bit of math that goes along with this, but the point is, when we start losing our itemized deductions and our exemptions, our effective tax rate starts going up.
And it looks pretty painless, but that's where we're going to get rates on that chart Ted showed you that I put together, you know, where we're getting -- the rate is really not -- the top rate on interest income, for example, is not 43.4 -- the 39.6 plus 3.8, okay? That's not the rate. The rate is actually higher because of these phaseouts.
Now, to make it worse, when we talk about the net investment income tax, what happens is -- let's say you have managed money and you're paying a professional 1% to manage that money. In that instance, what we're up against is you're not going to be able to take that deduction against the net investment income tax, so that becomes a problem.
Now, the marriage penalty relief on the Slide 16, basically, prior to EGTRRA, married taxpayers sometimes paid more tax than two unmarried individuals. EGTRRA helped that, basically, by doubling the 25% bracket. The law here extended both these provisions, okay? So there is a little bit more fairness at the 10 and 15% brackets.
Now, in the next slide, we talk about the AMT. Over the past decade, the A- -- there's been a few patches. The new law makes these patches permanent and new AMT exemption will be 78,750 for married couples and 50,600 for singles.
Now, here's what we're up against. The AMT amounts are going to be adjusted for inflation in the future, but what happens -- and check this yourself. None of you will believe me because of your training, but the rate is 28%; we all realize that. But when you get into this phaseout -- we noticed this when we were doing Roth conversions. When you get into the phaseout and for every additional dollar of income, you lose 20% of your AMT exemption, the ef- -- the true rate, the incremental rate for the AMT is 35%. So test that and you'll see how that works.
Now, Page 18, on Page 18, we talk about a small tax -- 0.9%, just under 1% surtax on wages, okay? Now, so let's say that, at your CPA firm, you earn $260,000. If that were the case and you're married, your spouse does not work, then you have $10,000 extra income and you would pay, you know, basically $90 of this tax, just under 1%. There is no employer match on this tax. This is the 0.9% healthcare tax on earnings. Married couples, there's going to have to be a form when both people work to reconcile that back on their 1040 so that they can pay in that tax or so they're not overtaxed.
Now, on Page 19, we talk about a new tax called the 3.8% net investment income tax. We are waiting for regulations on this, but we've done a lot of work on this for the AICPA and for CCH and -- you know, this is a tricky tax. And, basically, when your income exceeds a threshold amount -- $250,000 for a married couple -- this is going to raise your rate. And your rate is going to jump from 39.6, if you're in the high rate, to 43.4. Now, that's from 35%, in essence, to 43.4. So if you have a client with substantial ordinary income, this is going to sting.
Now, there is a little bit of math. On Page 20, you basically have to take 3.8% -- and let's jump up one slide, please. 3.8% times the lesser of net investment income tax or the excess of MAGI over a threshold amount. So, again, what we're looking at is we want to figure out what is our net investment income -- which would be things like interest, dividends, etc. -- and then we compare that to a threshold amount and we have to bring in AGI into the equation.
Now, these taxes are all computed under Section 14-11 of the Code. Okay? They're all computed under Section 14-11 of the Code and the definition of MAGI comes directly from 14-11.
Now, so if your net investment income, if you're retired -- you had no other income but interest and dividends -- and that were $260,000, you're married, you can only 250, according to the threshold amount. You're $10,000 over and you're going to pay $380 of this additional tax. Now, for many of your clients, that number is going to be much, much larger.
Now, this tax, on Slide 21, also applies to estates and trusts, okay? So this applies to estates and trusts and, basically, what's going to happen here is everything -- if -- mostly income for an estate or trust will be income subject to the surtax and the cutoff right now is $11,950. So at $11,950, we basically are going to be in the 43.4% for estates and trusts; very, very troubling, okay?
And what this means is we have to do a better job of working with those clients to get distributions, okay? So we're going to have to do a better job of working with those clients to get distributions.
Now, my final slide is up on Slide 22. You know, basically, this is including -- what's included in net investment income? The things you would think: interest; annuity distributions; dividends, qualified and ordinary; rents; royalties; income derived from a passive activity. Your great-grandfather started the Ford dealership in your town. Your brother is running it; he owns half and you own the other half of the stock. Your income is going to be subject to the net investment income tax. Your income from that business, because you're passive, but your brother, who goes there every day and works, his will not be subject to the 3.8% tax.
Now, net capital gains derived from the disposition of property? When you go to sell, your portion will be subject to this tax; your brother's will not.
What's excluded? Salary, wages and bonuses; distributions from IRAs or qualified plans; active royalties; gain on the sale of an active interest in a partnership or S corp.
And the AICPA actually has four seminars coming up on this. A general overview of the 3.8 followed by specific seminars on S corporations, partnerships and estates and trusts, so there's a lot going on going forward.
So that's basically my summary and I'm going to turn everything over Scott Sprinkle, who will talk about some planning strategies.
TED SARENSKI, CPA: Yeah, thanks, Bob. You know, you got everyone concerned, let's have Scott maybe try to help people decide how do we mitigate all those taxes you just talked about, Scott.
SCOTT SPRINKLE, CPA: Great, thanks, Ted. I think, you know, Bob and Ted gave everybody a general idea of how complex this becomes and I think the big thing that CPAs and planners need to realize and cli- -- you have to educate your clients. Is the old rules of thumb just don't work. I mean, if you are in the -- if you're extremely wealthy and multimillions every year, then maybe the old rule where you just deferred income and tried to accelerate deductions works.
But, for most individuals, if you're making $600,000 or less, you should be doing this income slotting and trying to plan as much as possible as to "How do I bring in the income?" We might actually be accelerating income into years, volunteering to pay tax at lower rates and so we're going to go from income tax planning to what we'd call income tax slotting. And, to Bob's point, it means multiyear scenarios; you can't just look at one year, when you're going through the planning process.
I think, this year, when we were doing returns for executives, a lot of times, executives are just put on a safe basis at 110% of the prior-year amount, particularly when there's a good year, markets have been recovering, we're seeing higher bonuses, higher restricted-stock payouts when they vest, stock-option exercises. And I think that what everybody needs to keep in mind, we're seeing a lot of clients that, if we had waited until April, would just be shocked at what this change in rates has been, because it's not moving from just 35% to 39.6. And if you have non-statutory wages, where the company was only using the safe harbor withholding at 25%? You really need to get with those clients right away, because, from a cash-flow planning analysis, a lot of them are going to be shocked come April with what's happening here.
So this multiyear planning's going to become very important. Again, accelerating income, harvesting capital gains may make sense in some instances. We're managing the 250 limit and the 450 limit for the capital gains, so you're going to be using all these thresholds and it's not as simple as just defer, defer, defer.
The other thing, as far as a focus on tax-exempt income, retirement account distributions, there's, again, when we're going through the net investment income and what qualifies and doesn't qualify, there are a couple safe areas -- and tax-exempt income being one of those -- that we can use to kind of shelter the taxes.
And then, again, year-to-year monitoring is going to become extremely important. It's going to be at least three- to five- if not, like Bob said, ten- to fifteen-year analysis on what we're doing from the planning perspective, for what we can do to help clients save money.
Next slide goes through a couple other ideas. One of the things we're looking at quite a bit on the -- is Roth conversion. And I guess a couple notes. One, even your clients -- and where you have a lot of opportunity may be with your widows or some of your retired clients that just don't have a lot of income. A lot of times they have low-hanging fruit, because you have the donut for capital gains rates, where they're -- with qualified dividend capital gains, basically, go tax-free for these individuals at lower income levels.
And they also have the ability to convert IRAs to Roths and so, even for those clients that are at the lower levels? This multiyear planning is huge. But the Roth IRAs, we're using this one -- I think it's a great asset, it's probably the best asset that you could let your kids inherit. So if you have large IRAs, the ability to convert these, let the kids inherit it. Once you've converted it, you do not have any RMD issue, so we're helping out from that standpoint. We're still getting the tax-free compounding. And if you can do a Stretch Roth IRA, there's just not a better asset, in my mind, to inherit. So I've been counseling my parents on this, but it is -- it's a great opportunity.
A lot of times, what you're going to end up doing with the Roth conversion -- you may not do it all at once, you might do it over a multiyear plan. Again, you're going to be looking at your income levels and do a multiyear plan. You also might do a complete conversion and re-characterize or un-convert what you've done and you have until October 15th of the year after the conversion to make that decision. So you get kind of this free look.
So, a lot of times, we'll do some fairly complicated planning where we're doing multiple conversions by asset category or by asset into different Roths. And then conver- -- you know, looking at which ones work the best, keep those and throw the others out. So I think that's one of the things you want to look at.
Critical decisions on the conversion. Obviously, we want to look at "What's the tax rate today versus the future?" There's some compounding help on this, but you -- we need to make sure that we're not converting at the higher rates. We definitely want to use outside funds. You don't want to take money out of an IRA to pay taxes on a Roth conversion; it takes away a lot of the compounding. So you want to use outside funds when you're doing these conversions.
And then you also need to look at what we need for living expenses. To Bob's point, a lot of our clients wait until 70 1/2 to take required minimum distributions, when they're in a lower tax bracket. If they're in a 15, 20, 25% tax bracket, it may make sense to manage those distributions out over time or use a Roth conversion as part of that process. So, we're looking at that a lot, as far as what we're doing on Roth conversions.
And we want -- again, that last point is just making sure we're staying in that lower marginal bracket. We need to -- we don't want to be converting into that 45% bracket. Most clients, even if they have a very large IRA, we can manage distributions, starting at 59 1/2, at lower rates, so that's where we want to make sure you're looking at that marginal rate.
Moving to the next slide.
Oaky, so asset placement. This is going to become more and more important and I think CPAs and CPAs that manage investments have a huge opportunity here, because we understand the difficulty and all the issues surrounding the tax law. We're back into an area where you want to look at tax-deferred accounts and use those to shelter income-producing assets that may create that 3.8% net investment income. So it's going to be much more important where I place my assets.
You know, if I'm going to have taxable bonds, I probably want those in a tax-deferred account and then, in the taxable account, have municipal bonds or lower turnover stocks that are paying capital gains rates, so I can try to work my way around that 3.8% tax. Also, you know, we've got to worry about the capital gains rate differential from the 15 to the 20. So, all this, where my place my assets is going to become much more important.
The Roth conversions, we talked a little bit about the "free look" to the extended due date, so we're using that.
The annuities -- I think, to Bob's point, on some of these fees that you're paying to advisors for investment management? There's products -- you know, paying commissions are netted against the income, so you're getting the deduction upfront. So commissions are not going to -- they're going to be looked on as a little more favorable for tax purposes. Likewise, annuities and life insurance, where we're getting the opportunity for the deferral once again, is people get in these higher income tax brackets, going to have more opportunities for annuities. Hopefully, well-designed, low-priced annuities, but there'll be a bigger push for annuities. It'll be easy to be an annuity or an insurance salesman because of these tax rates, so you're going to see a lot of opportunity there.
The CRTs to manage capital gains and smooth income, Bob made the comment of the couple that have some land that they've held for a long period of time. A situation like that, either installment sale or using a charitable remainder trust, where we can smooth the income out over time. Put it in the trust upfront, take a deduction upfront, take an annuity back that we take that income over time, allows us to manage around the income. So I think CRTs are going to become much more in vogue.
And what we're working with a lot of clients that maybe the CRT doesn't make sense, but these charitable funds, whether it be the city funds or a Schwab or a Fidelity Vanguard, whatever the charitable funds that are out there, where you can put a large amount into the fund, take the deduction in one year. It's a way to manage around some of these $450,000 thresholds, $250,000 thresholds, so I think you're going to see a lot of clients willing to make multiple gifts into a charitable fund that they can then allocate to their charities over a number of years. But they'll -- it will help smooth their income and slot the income. So I think there's going to be a big boom in that area.
And defined benefit plans, particularly for closely-held businesses, smaller companies, always been a great ass- -- or a great way to defer taxes. So with the higher tax rates, I think deferred benefit plans are going to become more popular for individuals again.
And I th- -- this slide, I don't want to go through in too much -- I think this is another one of those slides you put with the Kitces slide and you just show clients the different types of income. And I think this -- we've -- tax simplification, hopefully, it comes someday, but we're definitely going the wrong direction right now. If you look at the different asset classes we have here or income classes and the different attributes, I think it's just a good tool that you can through and educate clients and show the value that you can have in this planning.
I think what you -- there's so much opportunity for clients to save a significant amount of money and there also needs to be managing their cash flow. I think a couple of these slides are just good tools where you can go through and say, "Okay, we have these different buckets of income and this is kind of the tax attributes and this is why we need to do the planning and this is what it can result to you." You can show value to your clients, you can bring significant value and have the opportunity to provide value to them while you can charge higher fees.
TED SARENSKI, CPA: Thanks, Scott.
SCOTT SPRINKLE, CPA: With that, Ted, I'm done with my slides. I'll pass it on to Beth, I believe --
TED SARENSKI, CPA: Yeah.
SCOTT SPRINKLE, CPA: -- for estate and trust.
TED SARENSKI, CPA: Yeah, that certainly helps out folks with some ideas as to what they should be talking to clients about before year-end. And one of the areas that has changed considerably this year, too, is estate, trust and gift planning. And, Beth, could you go through some of the changes and then maybe give some folks some ideas as to how they might use this to, again, talk to their clients and gain some billable hours.
BETH GAMEL, CPA: Absolutely, Ted, thank you. Before I, you know, get into my area, I just want to reiterate what I think you heard from both Scott and Bob, which is I think this is the perfect time for CPA folks and CPA planners to show their mettle. Because there aren't that many advisors out there that really have the sophisticated tax knowledge that are needed to -- that's needed to advise clients in the post-ATRA world and, you know, this is our moment to shine.
And I also want to mention this Michael Kitces chart. We've basically been bringing that to just about every single client meeting this year. And even though we've sent out client alerts explaining the aspects of the new tax law, seeing that chart, as overwhelming as it can be, has really made an impact on people and they really understand now the complexity of planning around the thresholds, the surtax, etc.
The areas -- in the estate, gift area, the ti- -- the clock isn't running. The clock really ran, frankly, last year, when the exemption was set at 5,120,000 and we really didn't think it was going to last and, so, a lot of planning for large estates was done last year. But now we know the law is permanent and we understand what the rules are we can kind of take our breath and -- well, at least hope that these are permanent -- and start planning again.
So the new -- what ATRA did was it made the estate gift and GST exemptions unified once again, which they were way back when. And set them at 5,250,000 for 2013. And, looking forward, we also know that they will be adjusted for inflation. So what that means is, you know, with a married couple, if you just multiply the 5.25 times 2, you know, they basically can pass together $10,500,000 of estate value, something that's far superior to what they've done in the past.
So the other thing is the top transfer tax rate did go up. It was 35% in 2012, but it was 45% in 2009 and many of us remember when it was even higher than that.
The other thing that we had that we didn't know would be permanent but now we know is spousal portability and I'll talk a little bit more about that. And it also extended the GST provisions.
So, if you can go on to the next slide, Ted.
The nice thing about the new law, in my view, is it's let us move away from estate tax planning, with the emphasis on tax planning, to what I consider to be true estate planning, the things, when people walk in your door, that they talk about in a sort of dreamy way about, you know, "This is the way I'd love to see my assets divided, this is like -- who I would like to benefit in my estate plan." And, since many individuals that we work with don't have estates that are greater than 10,500,000, they can do this without worrying about the tax implications.
So, from my perspective, this gives us the opportunity to really be planners and talk to people about some of the things that are very important to them and sometimes they're actually real stumbling blocks to good estate planning. I think -- I can't even begin to name the number of clients who just couldn't figure out a way to name guardians and then, you know, didn't sign their documents. When you talk to lawyers, very often, they say the same thing, that they've drafted these documents and people can't figure out who would be the best person to take care of their children if they were to die and they don't go any further with that. So we talk about guardians, we determine the beneficiaries of the estate, what are appropriate ages for distributing assets among beneficiaries.
Talk about trusts. Are they necessary? If you have them, you know, who would be the beneficiaries? How do you title assets? You know, we've always moved people away from joint ownership of assets and wanted them always to have separate title -- and I'm not talking about community property states, about which I know almost nothing. But those of us who live in states where assets are treated different- -- or separately. You know, titling assets are important.
It also gives us a chance to talk about important documents like powers of attorney, so that somebody could act on behalf of an individual who might not be able to make financial decisions.
And also talk about beneficiary designation for retirement plans. It's amazing to me how often people filled out their beneficiary designations on old IRAs or old 401(k) plans and, you know, still have former spouses or other folks that, you know, have passed away that are still named beneficiaries. So these are the things we all ought to be talking about when we discuss estate planning with our clients.
The nice thing that, you know, we have today is portability, which allows a surviving spouse to use the unused estate tax exemption of a deceased spouse. So, just in simple math, if you have a $5,250,000 exemption and the first spouse dies and that first spouse didn't fully use their 5,250,000, that can be made available to the surviving spouse so that a larger amount of assets can pass free of tax on the second death.
So that all sounds really great, but there are some implications to portability, which you need to think about before you just decide "Isn't that a great stopgap measure?" And one is that, even in a nontaxable estate? You will have to file an estate tax return, which could keep the estate open for quite a long time. The other thing is, if a surviving spouse remarries, that portability is lost.
Portability also does not apply for GST purposes. So, if an important part of your estate planning is to consider future generations, then portability isn't the soln.
And the other thing is there's no increase in value, so the assets that are surviving a spouse's death may very well have gotten a great deal larger if, in fact, you know, the markets have done well or a business has done well or whatever it is that's been left to the surviving -- for the survivor estate. But that unused exemption has not gotten any bigger. So, while you still have some protection, it may not be as large as somebody thought it might be at the first death.
So what are some of the things that we need to think about when we think about estate planning strategies? And one is that read your documents, read the client documents. This is an important element of your responsibility, if you're going to provide estate planning, because we know that many, many clients -- particularly married individuals, obviously -- before 2013, had a fairly standard kind of estate plan, where they had a credit shelter trust and QTIP trust. But these formula clauses really might not make sense, especially for clients who have assets well below the 10,500,000. It may actually just totally overfund the credit shelter trust, which is not something, perhaps, that that individual would want to accomplish.
So that's, in my view, you know, the important first step is read those documents that exist now and try to find out "What are the flaws in the -- in the documents as they exist now?"
The other is -- you know, is there an issue here with portability? Is there an opportunity for it? Is it something that we ought not to consider? How do we, potentially, plan for that? And -- but if we bring up portability, what about second marriages? I mean, those are things that people have to think about and so you want to really go through all the reasons for why you need a QTIP trust or bypass trust and, you know, where portability might figure in these -- this situations.
The other is, we still have to plan for those states where we do not have consistency between state and federal estate tax laws. I, for instance, are -- live in Massachusetts, which continues to have a $1,000,000 exemption? Far below 5,250,000, so there could always be reasons why you still want to use a credit shelter trust; for instance, to hold the estate tax exemption. There are, I think, today, 22 states plus the District of Columbia which do have their own estate tax, so you need to keep that in mind.
The other is -- you know, for long-term marriages, you know, could we go back to something like leaving all the assets to the surviving spouse and allowing them to use some disclaimers? It's probably not the option that most people would really like, but, you know, there are marriages, believe it or not, that last for a long time and where people get along really well and they have children only from that same one marriage. So they might want some flexibility and, with this large exemption, that might allow them to do that.
I think it was Bob that touched on the healthcare surtax on trusts and here's a situation where you really, really -- if you are advising a family where there are trusts for a variety of beneficiaries along with individual assets, if, in fact, you have the flexibility of determining when distributions are to be made, then you probably ought to be looking at the tax returns of all of the beneficiaries.
Because, if you can get them -- if they are in lower tax brackets and potentially not subject to the 20% long-term capital gains rate and the rate on qualified dividends and not subject to the 3.8% surtax. But if you kept that income within the trust and you were then very quickly moving to the 20% rate and the 3.8% surtax, that family is going to be pretty unhappy knowing that there was that kind of flexibility and, potentially, no one took advantage of it. So that's a very important thing to look at, if you're advising families where there are trusts.
Of course, there are still always reasons why you don't want to distribute from a trust. There could be beneficiaries who are not be trusted with large distributions or you run into kiddie tax issues or perhaps there's a pending divorce or some kind of financial irresponsibility on the part of the beneficiary. But, at least as a fir- -- at a first pass, you should be asking about the tax rates of those beneficiaries.
The other topic that I think the changes in the estate tax give rise to is "What's life insurance?" You know, we always know the reasons why people bought life insurance when they bought it, besides just being pushed by an insurance agent. But, rather, the very valid reasons like they needed income replacement, if one of the spouses were to die; they want to be sure that the -- there's money to, for instance, pay off a mortgage or educate their children should one of -- should somebody die relatively young. And, if those reasons still exist, then there's every reason in the world to think that that is life insurance that you should maintain.
But a lot of life insurance was sold to create estate liquidity. And if, in fact, you've got clients who it's not very likely their combined estates will ever reach ten million or more, then the question is "Is that -- are those policies still useful? Ought you to keep them? Is there another purpose -- a way to repurpose those policies or simply not have them any more?" depending upon what the client wants to accomplish.
But this is a great opportunity to really think about "What is the purpose for these policies today? Might they exceed your current needs?" And then, also, "What kind of a policy is it? Is it term, is it whole-life, is it no-lapse? And what works best in the post-ATRA world?" So some of the com- -- the topics that I would suggest that you think about, particularly when you sit in front of some of your more well-to-do clients, are "Let's talk about your life insurance."
And, on the next slide, I think some of the issues are "Is there a way --" now, keep in mind that a lot of people do own policies in trusts. And there isn't as much flexibility as there is when you own the policies personally.
But I think, if you own the policies personally, particularly, there could be a great reason to keep, particularly, whole-life life insurance. And that is that, when you think about this 39.6% bracket and the 3.8% surtax, wouldn't it be great to have something that's building up on a cash -- on a ta- -- income-deferred basis? A tax-deferred basis. So you could actually think about your policy, which maybe, at one time, you were -- you bought for estate purposes or something else. But, today, actually, could be a way to supplement your retirement. It's -- you can borrow against that policy when you get older and perhaps need that -- those assets to supplement whatever other sources of retirement you have.
Some ultra-high-worth individuals might actually want to use some or all of their $5,250,000 exemption and buy a huge policy and maybe they also want to use it to keep -- to -- that's where they want to do their hedge fund investing, because we all know that hedge fund investing is incredibly tax-inefficient. You know, you have a lot of shor- -- very often, short-term gains and dividends that are not qualified and so you really have a pretty significant tax bite, which is only getting worse because of ATRA. And so that might be the place to put that type of an investment.
Then, for policies that you do have, that you find a reason to perhaps keep, but are just too large for the purposes for which you need them today. For instance, the kind of policy you bought for estate liquidity purposes when you thought you were going to have an estate that is largely taxable and now you realize most of it is not going to be taxable, it's a good time to look at 1035 exchanges. Maybe you could -- you know, or shrink down the policy or do something so that you retain the insurance that you paid all those premiums on over the years, but get a kind of a policy that is more favorable and more useful than the kind that you have now.
So I'm done with my section.
TED SARENSKI, CPA: Great. Thank you, Beth. Hopefully, everyone has jotted down some of these ideas as we've gone through. This is certainly, as we've talked -- each of them, Scott, Bob and Beth just now -- that face-to-face meetings, talking about tax projections and here we're seeing, on this slide, just compare 2013 to '12. But, beyond years, what about '14, '15? Looking at many, many years. Getting in front of people. This is the time to really show -- and Beth said this, I think, really well -- demonstrate your value, grow your practice, sit down in front of your clients, show them how complicated this is, show them what's going on and just understand -- have them un- -- get them to understand, I should say, that it is not a simple tax structure, as Scott kind of joked about.
What I'd like to do is get through some questions that have come in while we've been talking. And the first couple came in while Bob was speaking about the 3.8% Medicare tax. The first question said, "There was a gain on a personal residence over the 500K for a married couple. Is that subject to the 3.8% tax?" Bob? And then the second question was "A trust has 150,000 of income, but it's all long-term gains and qualified dividends. What's the rate of taxation?" So two different questions there about your 3.8%. Bob, can you give us some answers on those?
ROBERT S. KEEBLER, CPA: Sure. On the trust side, if your income is over the $11,950, it's going to be s- -- and it's not from the active-tr- -- you know, this active trade or business, it is going to be subject to the 3.8% surtax, okay? So that's basically what the law provides.
Ted, read that other -- the first question, though. I want to make sure I understood it.
TED SARENSKI, CPA: The gain on the personal residence was over 500K for a married couple --
ROBERT S. KEEBLER, CPA: Right, yep.
TED SARENSKI, CPA: -- so is that part --
ROBERT S. KEEBLER, CPA: Going to be subject.
TED SARENSKI, CPA: It is going to be subject. If they're over the 250.
ROBERT S. KEEBLER, CPA: That's -- that's why -- a lot of people think that that's why they didn't release these regulations until after the presidential election, because the people in Treasury realized that would certainly -- that's something that's very easy for Americans to understand. And it seems inherently unfair.
TED SARENSKI, CPA: Well, they never talk about fairness when they talk about taxes. Scott, there was a question that came in regarding the Roth conversion. "For a young person, 32 years old, does it make sense to do a Roth conversion now, pay the tax and avoid tax on distributions thirty --" well, in this case, that would make him 62, but we'll say 30, 38 years from now, because retirement probably won't be until age 70 for this person.
SCOTT SPRINKLE, CPA: Yeah ...
TED SARENSKI, CPA: Should they do a Roth conversion when they're young?
SCOTT SPRINKLE, CPA: Yeah, Ted, I think young individuals in particular, they're -- you're in a lower tax bracket. There are a lot of companies now that have the Roth component of the 401(k) plan that's available too. But, yeah, I think young individuals -- for our wealthier clients, we have them working with their high school kids and doing like a matching program, where they're actually creating Roths for young children. It's just such a powerful asset and, if you're in a low tax bracket, to do a conversion, you get the free look, which -- so, if the markets implode and it didn't work the way you hoped, you can -- you can cancel it. So I think it's -- definitely, for younger individuals -- a huge opportunity.
For -- you know, it's -- where it gets harder is when you're in the higher income tax brackets. And, for those individuals, you may have to take a free look and kind of have the market help you get there? But, for young individuals, it is definitely something that you want to look into.
TED SARENSKI, CPA: Great. I would just add, too, that, if you have clients who have children who out there working and they're in -- you know, they're 16, 17, 18, all the way up to -- through the time they finish college, open a Roth for them if they don't have the money. Get them into a Roth account today, with the low income levels that they have, so that they can earn money down the road, where maybe they won't be able to personally contribute, but they'll have a good basis to start.
Beth, there was a question that came in regarding the ILITs, the life insurance trusts that you were speaking about. And that is that -- let's say it was set up for estate purposes, as you mentioned, and now they decide they don't want that any more. Do you -- can you dissolve the ILIT? Do you -- or just stop paying the policy and leave the ILIT? What could someone do in that situation?
BETH GAMEL, CPA: Well, yeah, there are a variety of things that people can do. You know, obviously, I -- if you've been paying premiums for quite a while and it's whole-life policy, you've probably got cash to render value in there. So, you know, you don't want to just kind of -- you don't want to just stop paying premiums and have it sort of implode eventually; that's not a smart thing to do.
What you might want to do are a variety of things. One is you could take the cash value out, which would then belong to the trust, so that would sort of be the first place. So you need to ask the question, "Is this trust valuable in some way? Do I still want it?" And it -- especially because it's an irrevocable trust, you know, you -- that's what it is. You have to leave it there, so they cash value, though, could be invested in some other way.
Another possibility is that you go to the agent and you say, "We want -- just want to shrink down this policy. It's now --" call it "-- a million dollars and, frankly, we don't see the need for a million. What can we do? We've paid X dollars in premiums now. What amount of insurance will that buy?" And just let them shrink down the policy.
And the other is you can do a 1035 exchange within the trust itself and get perhaps a better policy. I know that some policies that didn't exist a while back, you know, are the no-lapse policies and, very often, the amount of cash-to-render value that's in the existing policy is adequate to give you a fair amount of death benefit and never pay any premiums again.
TED SARENSKI, CPA: Great. Bob, I'm going to combine a few questions and ask you the question. They're all regarding the 3.8% Medicare tax. Are there deductions that can be used to offset investment income? The question was maybe state income tax that could be allocated or investment fees could possibly be allocated against that. Another person to add on to that, distributions from S corporations; let's say excess of basis or even just your regular net of S corporations. You know, are those included in investment income? So some questions, again, regarding any deductible items against investment income and then, when we look at partnerships or S corporations, what about the bottom line on those?
ROBERT S. KEEBLER, CPA: Sure, the S corporation is just going to turn on whether you're passive or active. And I don't think if it -- if you are in excess of basis, what happens is that's typically taxed at the capital gains rate; that's not going to impact. It's -- the test is whether you're passive or active and whether there's an underlying trade or business to start with. So, as long as have a -- the Ford dealership, for example. You're not going to pay any tax if you're an active owner.
Now, you are allowed to deduct state income taxes against the net investment income tax, period. The law allows that. However, I suspect there'll be a debate on how to compute that? For example, if you're in a state with graduated rates, do you treat the net investment income as the last dollar or the first dollar? Also, what if -- you know, certain types of assets are exempt for state taxes and others aren't. This could be a -- I suspect the actual accounting, the tax accounting here is going to be a nightmare.
Now, let's say someone manages my money and I pay them 1% to do that. But that deduction never makes it to my front page of my retur- -- or to my itemized deductions, because I'm subject to the 3% scale back and the 2% of AGI limitation, okay? Now, in that case, I am not going to be able to deduct that, Scott, for purposes of the net investment income tax. So what happens, guys, is you are -- the -- I believe what that means is, if you're paying a 1% management fee on a 10% return, your 3.8% surtax just became more like 1-point -- 4.1 or 4.2%.
So 3.8 is a misnomer, because you're not going to be able to deduct all these expenses.
TED SARENSKI, CPA: Hm. Bob, one more quick question and we'll go -- use your Ford dealership as an example. You've got two brothers -- one active, one inactive -- and they also, the two brothers, own the building that the Ford dealership's in and they pay rent to this separate entity, an LLC that owns that piece of real estate, where they're both members. Is that investment income for each of them? Is the active one going to be considered active or are all rentals passive?
ROBERT S. KEEBLER, CPA: Well, this is called self-rental. And, according to the team that's writing the regs for the Service, self-rentals, at least in the first version of the regs, will be subject to the 3.8, even if you are active in the trade or business, okay? So take, for example, Ted, your financial planning firm. Your financial planning firm pays rent to you -- to the entity that owns your building, that is self-rental and you're going to pay that.
Now, the way around that. Let's just say you have a grocery store, okay? And I have a gentleman, I think he has eight grocery stores, it's a pretty big operation, and these buildings are all worth two, three million dollars each, sometimes more. And let's say we drop all those buildings into -- they're already LLCs. Let's say we put all those under a holding company that's an LLC and we put all his grocery stores under the same LLC. The underlying entities are disregarded, so the planning would be to set up disregarded entities, have the leases be between disregarded entities. You have the same degree of asset protection, but you eliminate the 3.8% surtax.
If anybody wants to know more about this, just send me a note, I can send you some slides I have on it. But, Ted, there's gonna be a ton of planning once the final regs come out.
TED SARENSKI, CPA: Great, thank you, Bob.
And thank you, everyone, for joining us today. I'm going to turn this over to Andrea Miller of AICPA to review a couple more slides for us. Andrea?
ANDREA MILLER: Sure, thank you, Ted, and thank you so much all of you -- Beth, Ted, Bob and Scott. Just to emphasize how much we rely on them from AICPA. These four individuals are at our beck and call, whenever we need help on anything to get out to the membership and to help you all be able to plan and advise your clients and not have to recreate the wheel across the country.
And, along those lines, I think, Ted, this is probably the only slide we need to cover; we don't need to get further. For those who need more in-depth resources to be able to take some of these ideas that were presented today to action, we have a lot of PFP resources, aicpa.ought -- aicpa.org/pfp.
We have an in-depth CPAs Guide to Financial & Estate Planning, Volumes 1-4, that is about a thousand pages. If you want a lot of content, that has been updated for ATRA and the net investment income tax.
We also have a lot of resources on planning after ATRA and the net investment income tax that can be found at aicpa.org/pfp/proactiveplanning; you can also just go to our home page and you can see that there. What has been collected there are all of the webcasts that we have done on this topic, all of the podcasts that a lot of -- has been put together by Bob Keebler. There are all kinds of formats and ways to get information.
We have -- Bob recently recorded ten podcasts that give you planning in bite-size pieces, so that you can take one idea at a time. He has a lot of charts that are on -- in this toolkit. You see, in your resources today, that he had the capital gains harvesting chart, the year-end planning chart, the income-shifting and income bracket strategy chart. All of those can be found -- some of those haven't been posted yet, but they'll be there by early next week in that toolkit; again, aicpa.org/pfp/proactiveplanning.
Also, for those who need a lot more depth of content, Bob has been working on two products that will be out shortly. One is The 25 Best Planning Ideas that will go in-depth into 25 core ideas that you can implement, either before year-end or a lot of them will carry into what to do with your clients, you know, under the new environment with ATRA and the next investment income tax.
Also, Bob and Scott talked a lot about having to plan over 15- and 20-year periods now so that you can manage the tax brackets and look at these strategies and what your income levels are for your clients and really figure out where this fits it and where they should implement various strategy and in which year to make sure it all comes out as effectively as possible. And we will post those when they're available for sale.
The -- it's a capital -- it's not a capital gain, but -- that's part of it, but it's a tax rate evaluator. So, basically, it supplements anything that you would do with BNA or software like that, but really helps you plan these strategies and think about Roth -- "Do Roth conversions make sense? Does capital gain harvesting make sense? Where do the PEP and Pease come in and how -- when do you hit the $400,000 threshold and the $250,000 threshold?" So it tries to work through all of that to help you figure out the long-term planning for your client.
But, again, we will post that, as soon as those products are up and available for sale, which should be -- next week, I'm hoping, Bob. You can chime in here if you know something I don't. But we will include links to how to purchase those products in that toolkit. Again, aicpa.org/pfp/proactiveplanning.
And, finally, I will just mention that Bob and everyone here will be at the AICPA Advanced Personal Financial Planning Conference in January. This conference has now become known as the most technically advanced event in financial planning in the profession, both inside and outside the CPA world. Scott's the -- Scott Sprinkle is the chairman of that conference and really is the place for CPAs doing any of this work to come together annually. And this will be a big theme of topic at this conference, where you can talk to these speakers, your peers, other experts and just really dive into all of this and how to best advise your clients.
With that, unless Scott or Bob want to say anything else, either about these resources available or about the conference, I think we're done. The conference, you can go to cpa2biz.com/pfp to find out more about that conference and to register.
ROBERT S. KEEBLER, CPA: Andrea, it's Bob.
ANDREA MILLER: Go ahead.
ROBERT S. KEEBLER, CPA: What we've done is we've worked really hard to put together some graphics that will help you see quickly what rates -- you know, what -- where -- how much room you have between brackets, how valuable.
And one of the big things there's going to be an emphasis on, which we all talked about today is, you know, if you're in the 0% capital gains rate, do you harvest capital gains? That's easy. But what if you're in the 15% rate? Do you harvest to go up to the 20 -- so you don't go up to the 20% rate later? It's these type of financial/tax questions that have never been answered before and we're starting to put together some tools.
I think what will happen is we'll look back three years from now and see how little we knew today, but it's kind of a collective effort. Once we put these things out there, thousands of CPAs across the country will have comments for us -- this is what has happened in the past -- and then we'll build a better mousetrap from there.
So we're excited to get started on this and, Andrea, we'll have more out shortly.
TED SARENSKI, CPA: One other comment, Andrea. You mentioned that these would be available for purchase. If you are a PFP section member, are -- do you also have to pay for these materials or will they be provided?
ANDREA MILLER: That toolkit that I made reference to has a lot of content. The -- all of the webcasts we've done, archived; a lot -- all of these charts that Bob's talking about; the Kitces chart is in there. We have letters that you can use to send to your clients to get them to understand the urgency here to want to engage in year-end planning with you.
Just -- the items that go more in-depth like the tax rate calculator and The 25 Best Planning Ideas that are the two products that Bob has been putting together, those are for-sale products and there are PFP/PFS member discounts to those products. But those have gotten a lot more in-depth and so there is a cost, although very small cost in the scheme of things, so that people don't have to recreate the wheel in their own practice.
TED SARENSKI, CPA: Okay, thank you.
ANDREA MILLER: Okay, well, thank you, everyone for attending today. That you so much, Beth, Scott, Bob and -- who did I miss there? And Ted. Thank you so much for your time today and thank you all for attending and, if you have any questions at all, feel free to contact the PFP staff at firstname.lastname@example.org. We can get you in touch with Bob, we can show you how to find these resources or answer any questions at all.
Thank you so much and have a wonderful weekend.