A Key Part of Estate Planning? Income Tax Planning

It’s been two years since Congress enacted the American Taxpayer Relief Act (ATRA), which increased the federal estate and gift tax exemption to $5 million and the maximum estate, gift, and generation-skipping transfer (GST) tax rates from 35 percent to 40 percent.

For 2015, taking into account the inflation adjustment, the federal estate and gift tax exemption is $5.43 million for each individual, or $10.86 million for a married couple. The ATRA also made permanent the portability feature introduced in 2010. The portability provisions allow a surviving spouse to combine the deceased spouse’s unused exemption with the surviving spouse’s exemption, thereby effectively assuring that married couples utilize their full exemptions.

With respect to the federal income tax, the ATRA increased the top individual income tax rate from 35 percent to 39.6 percent and the top capital gains rate from 15 percent to 20 percent. In addition, the Affordable Health Care and Patient Protection Act added the 3.8 percent income tax on net investment income (NII). Therefore, taking into account the 3.8 percent tax, the top federal individual income tax rate can reach 43.4 percent for ordinary income, and the top rate on dividends and long-term capital gains can reach 23.8 percent.

Keep in mind, the 3.8 percent tax only applies to individual taxpayers whose modified adjusted gross income exceeds $200,000, or $250,000 for married taxpayers filing jointly. The 3.8 percent tax also applies to trusts when the adjusted gross income of the trust exceeds $12,150. Because of the ATRA, the increase in the federal estate and gift tax exemptions, coupled with the increase in the top individual income tax rates, has now shifted the focus of estate planning to include income tax planning.

Two Income Tax-Planning Strategies to Consider

Traditionally, estate tax rates exceeded income tax rates, but the ATRA has closed that gap significantly. Now, individuals are well-advised to consider income tax-planning strategies where they had not done so previously.

Here are two approaches:

1. Assign income from a taxpayer in a high-income tax bracket to a taxpayer in a lower bracket: For example, gifting income-producing assets to a complex trust allows the trust to shift taxable income to beneficiaries in lower tax brackets.

2. Avoid the phase-out of itemized deductions and personal exemptions: By reducing one’s income, taxpayers may be able to decrease the phase-outs of itemized deductions and personal exemptions.

To read the entire article, please visit www.accountingweb.com.