Yesterday was April 15th. In the United States, most taxpayers were required to file their federal income taxes, or at least pay (if they owed) and file for an extension. So, today I thought I’d focus on a little income tax planning that can help your clients.
In the past few years, high-earners have faced a two-pronged challenge. The top marginal rates have increased to 39.6% on ordinary income and to 20% on capital gain income. Additionally, couples with income above $250,000 and single individuals with income above $200,000 face a 3.8% Medicare surtax on net investment income.
Let’s look at a quick example. John and Mary are married and file a joint tax return. They have baseline AGI of $100,000. They have a stock which they purchased at next to nothing. It is now worth $1.5 million. If they sell it directly, they will pay the 3.8% surtax on $1.35 million, costing them more than $51,000. In addition, they will pay capital gains tax at a rate of 20% to the extent their income exceeds $457,600 this year. Being taxed at 20% on much of the income, instead of 15%, will cost them more than an additional $57,000.
Instead, if they set up a charitable remainder annuity trust, with a 10% annuity payment to themselves for 10 years, they will get a charitable deduction of more than $180,000. The income they receive from the CRT will be flavored by the income tax recognition of the CRT itself. Assuming the CRT reinvests for capital gain or tax-free income, the payments to John and Mary will be capital gains income.
So, John and Mary will receive $150,000 annually for ten years from the CRT. That will bring their AGI to $250,000 per year. As a result, during the ten years, they will never pay the 20% capital gains tax and they will never pay the 3.8% surtax. This strategy would save them more than $108,000 in taxes, not including the value of the charitable deduction.
This example shows how a CRT may be a very useful strategy for deferring gain and thereby avoiding the 3.8% surtax on net investment income and the 20% capital gains tax rate.
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