Topics for today • New tax legislation avoids the fiscal cliff • Health-care reform law introduces two new taxes beginning in 2013 • Longer-term outlook on taxes • Tax-smart planning considerations and strategies
The American Taxpayer Relief Act of 2012 • Bush-era tax cuts extended permanently for most taxpayers • Many popular tax provisions extended • Benefit of tax deductions reduced for some • Alternative minimum tax (AMT) permanently indexed for inflation • Emergency unemployment benefits extended but payroll tax reverts to 6.2%
Many tax provisions extended at least through 2013 • Relief for families funding college education • American Opportunity Tax Credit, deduction for tuition expense, student loan interest deduction all extended • Contribution for Coverdell Savings Accounts set at $2,000 • Tax-free IRA distributions to a qualified charity returns • Deduction for state & local sales taxes extended for 2013 • Permanent fix for the “marriage penalty”
New health-care taxes take effect in 2013 • Affects taxpayers with more than $200,000 in income ($250,000 for couples) • Increase in the individual portion of the Medicare payroll tax on wages from 1.45% to 2.35% • New Medicare net investment income surtax of 3.8% • Interest, dividends, capital gains, rental income, passive business income all subject to the new tax • Interest from municipal bonds and distributions from retirement accounts are excluded The threshold for the 3.8% net investment income surtax is based on modified adjusted gross income (MAGI), defined as adjusted gross income plus net foreign income exclusion amount. The extra .9% Medicare payroll tax is based on earned income only (salary, wages, etc.).
Married couple with income over $250K: How does the new 3.8% surtax work? $50K Muni income Not subject to 3.8% surtax $50K cap gain subject to surtax $100K Cap gain $250K income threshold (MAGI) $50K cap gain not subject to surtax Not subject to the surtax but is included in determining the $200K/$250K income threshold $50K IRA income $150K Salary Simplified, hypothetical example designed to illustrate how the new Medicare net investment income surtax is applied. Beginning in 2013, the surtax applies to individuals with MAGI over $200,000 and married couples filing joint tax returns with MAGI over $250,000. MAGI defined as Adjusted Gross Income (AGI) plus net foreign income exclusion amount.
Federal budget deficit exceeds $1T for the fourth straight year Annual U.S. federal budget surplus/deficit, 2000–2012 ($B) ($) Source: Congressional Budget Office, Monthly Budget Review, September 2012.
Spending is high and taxes are low relative to historical averages Historical federal tax receipts and government spending (% of GDP), 1970–2012 Current spending: 24% Historic spending: 21% Percentage of GDP Historic taxes: 28% Current taxes: 15% 2012 1970 Source: Office of Management and Budget, 2012, historical figures are averages since 1970.
New tax deal projected to increase the deficit Estimate of the Budgetary Effects the American Taxpayer Relief Act of 2012, 2013–2022FY ($B) $ Source: Congressional Budget Office, January 2013. Estimate based on current law baseline assumption that the Bush era tax cuts would have fully expired after 2012.
The majority of governmentspending is on auto-pilot U.S. federal government spending by type, 2012 estimated Discretionary Social Security$773B Defense$709B 35% Medicare$478B Non-Defense$610B Mandatory 65% Medicaid$255B Interest$223 Other$670B Source: Source: Office of Management and Budget, September 2012. Mandatory spending types primarily include Social Security, Medicare, and Medicaid, as well as interest on existing debt. Discretionary spending includes defense and non-defense items.
What would a longer-term debt solution look like? Everything on the table — increased revenues, cuts in discretionary spending, major entitlement reform Thoughts on reforming Social Security Increase the wage base* Increase the retirement age for younger workers Utilize a different COLA formula for benefit increases Reduce benefits for higher-income recipients (i.e., means testing) Comprehensive tax reform? Less brackets and lower marginal tax rates, coupled with the elimination or significant reduction in tax preference items * Social Security wage base for 2013 is $113,700.
Five planning strategiesto consider in 2013 Invest in municipal bonds to generate tax-free income Municipal bonds are more attractive for taxpayers who are either subject to 3.8% surtax and potentially the high 39.6% marginal rate Utilize strategies to reduce or avoid taxable income Retirement plan contributions, flexible spending accounts (FSAs), deferred compensation may prevent a taxpayer from reaching income thresholds that may result in a higher tax bill Be mindful of transactions that may drastically increase income Consider Roth accounts to create tax-free income in retirement
Five planning strategiesto consider in 2013 Avoid taxes on IRA distributions by using a charitable rollover if over the age of 70½ Distribution (maximum of $100,000 annually) must be sent directly to a qualified charity More tax efficient than writing a check to a charity and then claiming a deduction on the tax return Review estate planning strategies and documents Even if estate taxes no longer a concern, it’s critical to plan for orderly transfer of assets or unforeseen circumstances Many states have separate estate or inheritance taxes Trusts should be reviewed in light of permanent $5M exemption amount
Five planning strategiesto consider in 2013 Consult with an attorney to see if more complex wealth transfer techniques may be appropriate Families with significant wealth, especially in non-liquid assets such as real estate or closely held businesses Potential strategies include grantor retained annuity trusts (GRATs), spousal lifetime access trusts (SLATs), family limited partnerships (FLPs), and dynasty trusts
Closing thoughts • Though the Bush-era tax cuts were extended “permanently” for most taxpayers, longer-term deficit pressures will prompt more discussion on taxes • There will likely be uncertainty around tax policy as potential tax reform is addressed • In this environment, tax diversification and tax-smart planning strategies and investment solutions will be at a premium
A BALANCED APPROACH A WORLD OF INVESTING A COMMITMENT TO EXCELLENCE | 22
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