I’ve blogged in the past about how a Charitable Remainder Trust can help avoid the 3.8% Medicare surcharge and the 20% income tax bracket for capital gain / dividend income. It does so by spreading income out and paying it out when the taxpayer is in a lower income tax bracket.

So, too, life insurance can be used as a way of avoiding these taxes. Life insurance is a tax-free wrapper that can be used to avoid or defer taxes. Only when more than the taxpayer’s basis (i.e., the contributions) is withdrawn from the policy is it subject to taxation. In the interim, the assets are able to grow tax-free.

With a CRT, you get a charitable deduction upon contribution. Of course, with life insurance, there is no charitable deduction upon contribution. However, the earnings inside the policy can be sheltered from income taxes. Thus, like a CRT, life insurance is a way of contributing assets and getting future income sheltered.

Thus, a taxpayer can buy a single premium whole life policy and the income on / growth of the funds can be sheltered. Eventually, when the death benefit is paid out, it goes to beneficiaries free from income taxes. Of course, the death benefit will be included in the taxable estate for estate tax purposes if the insured owns the policy or has any incidents of ownership, like the ability to change the beneficiary. Today’s $5.25 million applicable exclusion means estate taxes are less of an issue for most people. However, if estate taxes are a concern, an irrevocable life insurance trust is still a great way to remove the policy from being subject to estate taxation.

Life insurance is not for everyone. Some people have health issues that make the insurance component too expensive. Depending on the company and policy, there may be other management fees that bring down the overall return. However, it is an option worth considering as a way to lower your clients’ taxes.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

I had the privilege of attending the Carter Center’s Winter this weekend in San Diego.

Carter Center’s Winter Weekend

The Weekend was an opportunity for the many supporters of the Carter Center to gather in a relaxed atmosphere and learn more about the Carter Center and its many philanthropic activities, including: waging peace (through election monitoring and programs to advance civil rights), fighting disease (such as the near-elimination of “river blindness”), and countless other programs. Part of the Weekend consisted of an auction of various donated items and Presidential memorabilia. The auction raised $1.6 million in furtherance of the Carter Center’s activities.

While attending the Weekend, I had the pleasure of attending a replaying of the interview which President Carter gave to Piers Morgan last week on CNN. What was interesting was that President Carter himself was there to narrate the interview and answer questions from the audience. He has incredible energy and drive, especially for someone who, at eighty-eight, could simply choose to coast.

I have the great pleasure of serving the Carter Center as a member of its national Planned Giving Advisory Council. Just as the Carter Center serves the world, the Council serves philanthropic organizations and the estate planning community in general. The Council’s purpose is not just to further the Carter Center and its laudable projects, but the cause of philanthropy and estate planning itself.

The great work of the Carter Center reminds me how important it is to raise the topic of charitable giving during the initial consultation. The estate planning process is foreign to most clients. Even the savviest client may not know that there are options for charitable giving that can reduce the net cost. For example, a charitable remainder trust can provide a tax benefit for the client while benefitting the charity. Raising the issue does the client a service, as well as helping the broader community.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

As I discussed in last week’s blog, the fiscal cliff legislation, officially known as the American Taxpayer Relief Act of 2012 (“ATRA”) included increases in income tax rates for high-earners. For couples earning more than $450,000, the top ordinary income tax rate went up to 39.6% and the rate for long-term capital gains and qualified dividends went to 20%.

As I mentioned last week, in addition to the fiscal cliff changes, the 3.8% surcharge from “Obamacare” brings the new capital gains tax for high-earners in 2013 to 23.8% from only 15% in 2012. But, a Charitable Remainder Trust (“CRT”) can help.

Let’s look at an example:

Anne and Bob Client are both 65 and retiring next year. They have income of $575,000 in year 1. Thus, they would be taxed on any capital gains at 20% in 2012, plus the 3.8% Obamacare surtax. They had invested in Company A years ago. The stock is now worth $1 million and their basis is de minimus. If they sold the stock, they would have a capital gain of $1 million and would pay tax of $238,000. Also, their income would be boosted to $1.575 million and most of their deductions would be phased because of the “Pease” rules.

Instead, they could contribute the stock to a CRT. Let’s assume they are both age 65. If they received 10% of the value of the trust annually, the actuarial value of the contribution to the trust would be about $125,000. That would provide a real benefit to them in 2013, since they are in the 39.6% bracket and could take this deduction all in 2013 (less the Pease phase-out reduction of $8,200). Thus, the deduction would provide them a benefit of a tax bill that is $46,253 lower next April.

In addition, rather than paying $238,000 in tax, the distributions to Anne and Bob would be “flavored” by the income earned by the trust, essentially on a Worst In First Out or “WIFO” method. Let’s assume that the trust sells the stock and then reinvests for capital gains. Each year, as the couple receives their distribution, it will be considered capital gain income and taxed accordingly. But, it also has the effect of deferring the gain. Each year, about 10% of the gain is recognized for 10 years. A tax deferred is a tax diminished because of the time value of money. Moreover, when their distribution is received from the trust, it will be taxed at only 15% because they will be in a lower bracket at that time due to their diminished income in retirement. Thus, they’ve benefitted from the reduction in rate from 23.8% to 15%, in addition to the deferral.

Thus, a CRT can be a great solution for many clients with appreciated assets.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

We all know that the fiscal cliff legislation, officially known as the American Taxpayer Relief Act of 2012 (“ATRA”) made the estate, gift, and generation-skipping tax exclusion “permanent” (whatever that means in Washington) at $5 million (inflation adjusted). But, the legislation also included increases in income tax rates for high-earners. In fact, for couples earning more than $450,000, the top ordinary income tax rate went up to 39.6% and the rate for long-term capital gains and qualified dividends went to 20%.

In addition to the fiscal cliff changes, the 3.8% surcharge from “Obamacare” brings the new capital gains tax for high-earners in 2013 to 23.8% from only 15% in 2012. This is nearly a 59% increase in the tax rate, literally overnight. How can you help your clients in examining the existing laws to minimize the hit of these new taxes?

One way is to educate them on the availability of a Charitable Remainder Trust (“CRT”). A CRT is a tried and true strategy. This is not some newfangled, risky strategy. It is officially recognized in the tax code as a way to encourage giving to charity. With a CRT, an asset can be contributed and a charitable deduction is obtained, within limits.

Also, the income tax on any built-in gains is deferred. Of course, the gains are deferred until you sell the asset or otherwise trigger realization anyway. With a CRT, the gains are deferred even after the realization would have been triggered. This can be particularly attractive to clients now, when capital gains rates have just increased.

A CRT is a tax exempt entity and pays no tax itself. However, when distributions are made, they are taxed to the non-charitable beneficiary, who is ordinarily the client during the term of the trust. The distributions are “flavored” or “characterized” based on the history of what would have been taxed to the trust, had it been an ordinary taxpayer. So, if the trust sold a stock and recognized a capital gain, the distribution would be taxed to the non-charitable beneficiary as capital gain income. I’ll look at a more detailed example in my next blog posting.

However, this is a way to defer the recognition of income for many years. If the client / taxpayer is going to be retiring or otherwise will reduce their income in the future, the capital gain income might be taxed at a lower rate in future years. This might also be advantageous if the client were moving from a state with a high state income tax (like New York or California) to a state with no state income tax (like Florida or Nevada).

Clients may be particularly interested in hearing more about this strategy this year, when the sting of the newly increased tax rate is still smarting.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

Hardly a week goes by without news of yet another wealthy person giving away a large sum of money to a college, university, hospital, medical research facility, cultural institution, or any one of dozens of other institutions or causes.

The very wealthy are giving gifts at an astounding rate. The top five Forbes 400 members including Warren Buffet, Stephen Mandel, and Mark Zuckerberg, gifted a total of $3.7 billion in 2010 and 2011.

Clearly, many wealthy individuals view their legacy as more than the accumulation of financial assets. They want to be remembered for their charitable giving, for helping others, and to make an impact on society.

Of course, not just the super-rich practice philanthropy. Many people give meaningful gifts of all sizes or volunteer tirelessly for all sorts of causes.

So, what about you and your clients? Certainly many of your clients have an affinity to a cause or an institution and certainly some have thought about philanthropy. But perhaps they’re not aware of their options for giving, or of the tax advantages of doing so.

Here’s a handy list of ways for you or your clients to give back:

In kind. You or your clients may contribute your time or expertise to a charitable organization. While you cannot take a charitable deduction, but you get direct experience with the charity and how it uses its resources. That can be invaluable in determining whether it is a good use of your time and money later on.

Directly. This is the simplest form of giving, especially when there are no strings attached to the gift. This can be done during life, or a brief clause in a Will or Trust can suffice. This may be a good option for any client, especially for those with smaller gifts to bestow.

Retirement account gifting. A client can name a charity as a beneficiary to his or her IRA or employer-sponsored retirement plan. Of course, certain rules such as spousal approval often apply, so be sure to guide your clients accordingly. In 2011, individuals over 70 ½ can even do a “charitable rollover” of $100,000. This is a directly charitable contribution of the IRA during life. This can be advantageous because it avoids limits on income tax deductions, etc. But, hurry, the “charitable rollover” is set to expire after this year.

A charitable lead trust. This trust pays income to a charity chosen by the giver for a certain term. It may be set up during life or at death. After that term, the trust principal passes to family members or other beneficiaries.

A charitable remainder trust. This is the reverse of a lead trust because trust income is payable initially to the grantor or other non-charitable beneficiaries for the term of the trust. After that, the principal goes to the donor’s chosen charity. Again, this may be set up during life or at death.

Set up a private foundation. Individuals can make tax-deductible donations to a private foundation. Foundations can be trusts or non-profit corporations. Again, donations may be made during life or at death. For large sums, private foundations provide greater control for the donor but have significantly greater reporting requirements, etc.

Stephen C. Hartnett, J.D., LL.M. (Tax)
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com