What We Know....What We Don't Know
As an estate planner, this is a very confusing time. Why? With the upcoming election and continued Congressional gridlock, no one seems to know exactly what our federal tax code will look like in 2013. In addition, the further implementation of the Patient Protection & Affordable Act ("Obama Care") will have tax implications that will affect estate planning now and in the future. The Presidential and Congressional elections are essentially a public referendum on how we as a nation wish to see these issues resolved. Given all of that uncertainty, let's take a look at what we know and what we don't know.
What We Know!
Unless Congress acts, we face what has been politicized as the "Fiscal Cliff". This refers to two events that are to occur after 12/31/2012: (1) the "Bush Tax Cuts" are due to expire; and (2) automatic across the board cuts in government spending will begin. The impending Fiscal Cliff is a direct byproduct of Congress' inability to agree on what to do about federal spending, revenues and increasing the federal debt ceiling.
Congress and the President must work together to resolve a multitude of issues regarding: the national debt and how to generate future revenue for government spending; future tax policy and how that will affect economic growth; controlling federal spending; and agreeing on how to fund or modify federal entitlement programs. Inaction is holding the economy back and the choices that are made today to address these issues will have a profound effect for the next 20 years.
The Presidential and Congressional elections are essentially a public referendum on these issues and will likely determine how they are resolved at least in the near term.
If nothing is done to stop the impending tax law changes, the following will occur:
- The tax rates on dividend income and capital gains will rise for all income levels;
- High income earners may lose some deductions;
- The federal gift and estate tax exclusion will drop from $5,120,000 to $1,000,000;
- The maximum federal gift and estate tax rate will increase from 35% to 55%;
- Ordinary income tax rates will increase to pre "Bush Tax Cuts" levels; and
- Social Security taxes, which were reduced two years ago, will increase from 4.2% to 6.2%.
Other changes, that are due to take place in 2013 that are not part of the expiration of the "Bush Tax Cuts" include:
- High income investors earning income from dividends and capital gains will have to pay a flat 3.8% surtax on investment income;
- Individuals making more than $200,000 in wage income next year ($250,000 for couples) will see their Medicare payroll tax on amounts above these levels increase from 1.45 percent to 2.35 percent; and
- Taxpayers who itemize their deductions will only be able to deduct unreimbursed medical expenses that exceed 10 percent of their adjusted gross incomes; up from 7.5 percent now (this higher threshold will not apply to taxpayers age 65 and older until 2017).
What We Don't Know!
From an estate planning perspective, we don't know:
- Exactly what the federal tax code will look like in 2013;
- What will be done to negotiate the next debt ceiling increase;
- How will this resolution will affect the tax code, federal spending and changes to entitlement programs; and
- If there is a party change in the Presidency, will Obama Care survive?
Our recommended approach is to plan for the worst and build in flexibility. Possible strategies in a low tax environment that will soon become a high tax environment include:
- Take advantage of the present gift tax exclusion amount and make gifts of property removing it from future taxation;
- Covert your IRA to a ROTH IRA in today's lower income tax rate environment. Future ROTH IRA distributions will not be subject to income tax and the new health care surtax;
- Look to invest in tax deferred instruments such as annuities, municipal bonds, life insurance and master limited partnerships, which not be subject to the new health care surtax; and
- Exercise any stock options before December 31st.
It is important to note that the last time we faced an impasse on the budget, the deficit and taxes, Congress, during the lame duck session, passed a two year fix. It was this bill that extended the "Bush Tax Cuts" and gave us a $5,000,000 gift and estate tax exemption. Whether a similar bill will be passed this year will depend on many factors including the November election results.
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