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: (800) 846-1555