Robert Keebler

In May 2013, The Ultimate Estate Planner, Inc., released its premier issue of its free monthly estate planning newsletter.  This is a newsletter unlike any others out there for estate planning professionals.  Not only is it intended for estate planning professionals of all designations - - including estate planning attorneys, CPAs, financial advisors, life insurance agents, and even administrative staff - - but it is intended to be practical, timely and provide useful technical, legal and practice-management strategies that professionals can actually use in their practice.

IN JUNE'S ISSUE:

• "Green Book" Proposals and Income Tax Planning by Robert S. Keebler, CPA, MST, AEP (Distinguished)
• Fight Back Against "Commoditization" and Low-Priced Competition by Philip J. Kavesh, J.D., LL.M. (Taxation), CFP®, ChFC, California State Bar Certified Specialist in Estate Planning, Trust & Probate Law
• Advise Clients to "Shift" Opportunities Rather than Grab Opportunities Themselves by Jeremy Spackman, Esq.
• "Contextualizing" Life Insurance by Jason Oshins, Financial Advisor, MBA
• Five Simple Tips for Being a More Organized Assistant by Kristina Schneider & Megan DeLaGarza, Executive Assistants
• Announcement: Client-Friendly Laminated Charts and Handouts

CLICK HERE to read June's newsletter

Click the "Subscribe Now" icon below and make sure that you're signed up to receive our free monthly newsletter so you don't miss out!

Reproduced with Permission by and Courtesy of Leimberg Information Services, Inc. (LISI).  For information about how to subscribe to LISI, click here.

To download Leimberg Information Service's 60-Second Planner podcast, In re Huber, click here.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  If you are interested in a personal consultation for your office regarding how to make your office more efficient and how to improve the productivity of your attorneys, staff and advisors, contact us today at 1-866-754-6477 to find out about our upcoming event, "The Ultimate Level^SM".  Connect with us on Facebook, Twitter or LinkedIn.

Reproduced with the expressed written consent and permission from Robert L. Moshman, Esq., author of the The Estate Analyst. To contact Bob Moshman to be included on his distribution list of his monthly newsletter, e-mail Bob at bmoshman@optonline.net.

Actors, musicians, athletes, and Kardashians can become famous overnight, but notoriety doesn’t automatically mean financial security; sadly, it usually ends up meaning the opposite. Lottery winners and other windfall recipients often follow a similar path, even if their “stardom” is limited to local friends, neighbors, and family.

Celebrity wealth can evaporate along with fleeting fame. Celebrities also attract lawsuits, moochers, and scam artists. Professional athletes have all of these issues but in a condensed career that can be over with a single injury.

Let’s examine the special financial planning challenges of these estates.

Shooting Stars

Blazing a path across the sky, a star can be born suddenly and in brilliant fashion. This has been especially true in the age of the Internet and social media.

Until recently, for example, few people outside of South Korea had heard of a chubby singer in sunglasses known as “Psy.” Then his new song went viral. He sold only 100,000 physical copies of his new song—not enough to become wealthy.

However, with the new economics of music, “Gangnam Style” was viewed more than 900 million times on YouTube, netting Psy $1 million. The video was also downloaded more than 3 million times on iTunes, netting him $2.6 million. Fame led to product endorsements for $5 million. Stock in YG Entertainment, Inc., which manages Psy’s career, rose dramatically, thereby increasing Psy’s family’s wealth by $30 million (on paper) and increasing the company’s worth by $200 million.

All of this happened in the course of 6 months.

It is possible that Psy’s artistry will endure with one masterpiece after another like Mozart or The Beatles. On the other hand, there are long lists of previous one-hit wonders. Remember the Baha Men? Perhaps not. But you might remember their one-and-only hit, “Who Let the Dogs Out,” from 2000, which was ranked the third most annoying song of all time by Rolling Stone in 2011.

Actor Richard Harris, now remembered for playing the role of Albus Dumbledore, recorded “MacArthur Park,” a seven-minute song that peaked at #2 on the Billboard Hot 100 in 1968. In 1992, humorist Dave Barry’s readers selected it as the worst song ever recorded, but perhaps “Who Let the Dogs Out” could now compete for this distinction.

 The career of Harris, in particular, should be illustrative to Psy. Folks may recall the verse: “Someone left the cake out in the rain; I don’t think that I can take it, ’cause it took so long to bake it, and I’ll never have that recipe again.” But fads fade away, and interest decays into contempt. Harris relied on his acting career and other endeavors without ever finding musical success again. Psy’s career may consist of cameos as “the guy who once did the horsey dance.”

Planning With Stars

A celebrity with some sudden wealth may not be as easy to work with as a self-made entrepreneur who has learned to live without wealth and is instinctively conservative about planning for the future. Businesspeople may have a better grasp of financial and investment strategies and may be more disciplined about achieving goals.

“Stars and athletes are hard to represent,” warns attorney Martin Shenkman, “because you have to convince them not to rely on their circle of followers and advisors.” The fact that other teammates are working with a particular investment advisor doesn’t ensure the capabilities of that advisor.

Shenkman also warns about celebrities who succumb to peer pressure and take unnecessary risks.

“You almost have to undo the mis-education these stars have received about what planning should be,” says Shenkman. “They often hear wild stories about successes and they want to get in on the action. Some of these investments sound questionable, and some ventures smack of worse, including potential tax problems. So you have to guide the athlete past all of these preconceived notions and back to fundamental planning.”

Several basic planning techniques come to mind for someone of wealth who requires basic tax planning and asset protection. There are retirement plans, irrevocable life insurance trusts, domestic asset protection trusts, setting up LLCs and FLPs, and almost always a combination of these techniques.

Is there a particular technique or game plan that would suit the typical celebrity?

“There’s no such thing as a ‘standard trust’ or an ‘athlete plan.’ Looking for a magic bullet is a mistake,” says Shenkman.

Instead, he applies “the LEGO approach,” i.e., using building blocks.

“Evaluate what works for a particular client first,” Shenkman advises, “and start with proven planning components to put together the framework of the plan. The creativity of planning is to then take the LEGO in the toolbox and customize it into the right building plan for the client.”

Sport Careers

Well known estate planners Richard A. Oshins Martin J. Shenkman, Robert S. Keebler, and Eido M. Walny recently collaborated on a Webinar and PowerPoint presentation concerning estate and financial planning for athletes.

Oshins points out that typical athletes have a relatively short window for their entire career. For many, this is only the years spanning from about ages 20 to 35.

That career window may close suddenly. The average player in the National Football League is 27 years old and earns $1.9 million annually. But the average NFL career is only 3.5 years (Bloomberg Business Week, January 27, 2011.)

For Major League Baseball, career lengths vary a great deal. Nolan Ryan pitched for 27 years (1966 and 1968 through 1993). By comparison, Larry Yount was not as fortunate. In 1971, Yount was announced as a relief pitcher for the Houston Astros, but his elbow “popped” while he was warming up. His career was over. Ironically, his younger brother had a 20-year baseball career—Robin Yount was inducted into the Hall of Fame in 1999.

The Sports Cliché

Walny describes a classic example of an athlete’s attempt to get his financial planning in place. 

A huge, corn-fed young man from the Midwest came out of a “Big Ten” school and made it to the NFL as an offensive lineman. “I don’t want to fall into the same old traps,” he told his financial advisors. “I want to save my money.” He voluntarily agreed to live on a budget and work with a professional advisory team. He was heading in the right direction.

Then the vices of the League caught up with him. Spending began to exceed the budget, first slowly, then more rapidly. After a while, the financial advisor reminded him of his goals. “Don’t worry,” said the sincere young man, “we’ll pick this all up on the next contract.”

“But ‘NFL’ stands for ‘Not For Long,’ especially for offensive linemen,” points out Walny. “Flash-forward, the young man blew all his money, no ‘next contract’ ever came, and he ended up living in a stereotypical it’s-not-going-to-happen-to-me story.”

Insurance = Good

Where might one begin with an athlete’s plan?

“Contrary to the general perception,” says Walny, “a good place for athletes to start is permanent life insurance. I’m a big believer in insurance and the value that can be derived. Athletes get homeowners and car insurance, so expanding into life insurance is easy for them to understand.”

“You do have to combat the perception that purchasing insurance means you are going to die,” notes Walny. So the emphasis should be on the asset protection and investment benefits as opposed to the death benefits.

“Remember,” says Walny, “life insurance is a unique asset class that has tax-free accumulation and proceeds that avoid income taxation. With the higher rates that became effective in 2013, this is even more of an advantage. Insurance can be structured as a class of assets that creditors cannot attack, e.g., when it is held by a properly formed and funded irrevocable life insurance trust (ILIT).”

Walny also likes having the insurance as a starting point for more sophisticated planning that may include a beneficiary defective inheritor’s trust (BDIT), which can be ideal with athletes. If insurance is held in the BDIT instead of a separate ILIT, the athlete can access the buildup in value of the insurance if there are hard times.

“With a life insurance policy asset to work with,” he explains, “we can design an ILIT to provide added strategic function. However, the ILIT involves ongoing gifts to pay premiums. Without an ILIT, insurance is still valuable and can be put into a BDIT. The BDIT needs to be in the conversation because it has a self-sustaining method of paying for premiums inside the trust without ongoing gifts and Crummey powers. A BDIT also provides more control than an ILIT. For many athletes and stars, having multiple trusts can provide incremental protection, even from the athlete or star’s own fiscal irresponsibility.”

Career Earnings and Endorsements

“The threshold discussion is where athletes are in their career because that dictates what they can and can’t do,” notes Shenkman.

“If they are getting on in their career, have they amassed assets?  A young athlete just turning pro may have low endorsement value, so he can set up an LLC and sell endorsement interests to the LLC in trust and get it out of his estate in a prospective way before there is value. This might be wishful thinking, but it may work well. A more established athlete might benefit from the same planning, but the value of the endorsement contracts may be significant, and that will affect what planning can be done.”

Consider the value of endorsements for Michael Jordan. Although Jordan was earning $30 million per year in NBA salary at the end of his Bulls contract, his overall career earnings of $90 million only placed him 87^th on the all-time earnings list compiled by HoopsDoctor in 2012. The top earner of all time on that list was Kevin Garnett with $328,562,000, based on a longer career and more recent earnings.

Yet Michael Jordan currently has a net worth estimated at $650 million (despite a $138 million divorce settlement). The majority of his wealth came from Nike and other endorsements, plus good long-term investments. Today, Jordan continues to earn $80 million annually in endorsements—10 years after the end of his basketball career. 

Not every player gets the same endorsement opportunities or investment advice. Teammate Scottie Pippen earned $108 million in NBA salary but had fewer endorsements. He also made some mistakes, such as buying a jet and calling it “Air Pip,” two bad ideas in one. Some have suggested that Pippen has struggled financially of late.

Antoine Walker, who had NBA career earnings of $110 million, ended up in even worse financial shape and had to declare bankruptcy. His was a stereotypical example of lavish spending on too many cars, gambling sprees, and supporting a posse and family of 70 people.

BDITs for Athletes

A beneficiary defective inheritor’s trust (BDIT) is a good technique for an athlete for several reasons.

A BDIT involves having a family member, such as a parent, set up a trust and gifting $5,000 to start it. An athlete can then sell assets to the trust (but never gift to it). Because the athlete is not the settlor of the trust, the athlete can be one of the trustees, but it is generally advisable to utilize an institutional co-trustee in one of the domestic asset protection jurisdictions such as Alaska, Delaware, South Dakota, or Nevada.

A professional athlete is often the right age and has parents or other benefactors who can set up the BDIT. Athletes may also have significant assets of endorsement contracts that can be sold to a BDIT. Oshins suggests setting up a separate entity for non-salary income, such as endorsements, funds from autograph shows, or appearance fees, and that entity can be sold to the BDIT.

Instead of giving money out to family and friends and having them run off, funds can be earned inside the BDIT (e.g., by the business owning endorsement contracts that the athlete sells to the BDIT). The trustee can then hold the authority to take care of everyone.

“This locks in loyalty,” notes Oshins. If hangers-on turn on the athlete or girlfriends break up with the athlete, the trustee is informed and makes sure the trust funds are protected.

Some estate planning professionals have clung to older planning techniques and have been slower to take advantage of the BDIT. Oshins notes that part of the problem is that advisors need to learn how to explain the concept to clients.

Shenkman confirms this observation. “Planners fall back into a pattern of not using new techniques,” he said. “The comfort of an old shoe is common, even when better styles are available. Be mindful of differentiating a great technique from a clever technique that is mainly for getting the thought process going. On the other hand, practitioners can become too comfortable with their well-worn drafting tools. If you draft the way you did 10 years ago, then you are doing a disservice to your clients.”

Shenkman also provides an example concerning the use of favorable trust jurisdictions. “Most practitioners use the client’s home jurisdiction for every trust. But that is not always the right answer, especially for clients with the wealth and challenges of a professional athlete. I would not ask if a trust should be in one of the key DAPT jurisdictions; rather, I would ask if there is any reason NOT to do it in one of the four best jurisdictions.”

Meanwhile, Oshins has noted a growing appreciation for the effectiveness of the BDIT.  “People who do the BDIT love it,” he says. “Many life insurance companies employ it and have set up training sessions for their staff.”

The proof is in the results.

“I did a BDIT for a client and sold 30% of the business to a BDIT,” says Oshins. “The family could end up paying no estate tax and still control 70% of the business. It is working very well. I did another one for a wealthy family with many kids and moved hundreds of millions of dollars out of the estate very successfully.”

For the athlete, a BDIT with an outside manager may be better than a domestic asset protection trust, which is self settled (i.e., the athlete gifts assets to the trust). In contrast, the athlete gifts nothing to a BDIT, so it may be more impenetrable to creditors and others.

“Once you see all the legs of the octopus,” says Oshins, “the BDIT makes sense.”

Twin BDITs

Even though the BDIT works for transfer tax purposes (with assets growing outside of the athlete’s estate) and creditor protection, the athlete, with a track record as his own worst enemy, serving as a trustee, could be the Achilles’ heel of the arrangement.

“Most of the athletes form an FLP or LLC for the ancillary assets instead of having the trust hold these assets directly. Some have family members employed. And they buy a house for their mom. But the athlete may not be disciplined enough to control these entities.”

The solution, says Oshins, is to set up two separate BDITs, one with the athlete and his associates as trustees, and another with only a professional trustee who buys a house for the athlete, invests in life insurance, and establishes a portfolio of conservative investments. If the athlete commits a crime or is exposed to liability, the conservative portfolio will provide future security. If the structure is raided, even by the athlete on a spending binge, the independent trustee can hold the fort.

“The conservative BDIT is your atom bomb money,” explains Oshins. “If everything goes bad, then there is at least a house, life insurance, and funds. And if you have professional advisors for the investment portfolio and something is done improperly, they can be held accountable.”

Walny concurred with this approach. “Athletes do get into trouble with their own control. It is difficult in professional sports because athletes keep up with the wealth displays of others. At the end of the day, it is useful if the athlete is not in a position to have to say no to family and friends but can instead direct them to the trustee. This takes a lot of stress off the athlete. This is true of a BDIT or any other trust—empowering athletes to concentrate on what they are good at.”

Shenkman notes that the BDIT addresses a fundamental element, i.e., the psychology of the athlete. He compares it to what happens to lottery winners.

“It is very hard for people to realize that you can blow through a big pot of money at a shocking pace. Everyone understands the rainy day concept. This is the piggy bank that even the client can’t break into. Everyone wants to be in control, but you need some funds that are immune from coercion and even mistakes you might make yourself.”

Many thanks to my distinguished guests for their excellent input. Robert S. Keebler, CPA, MST, AEP (Distinguished) is a Partner with Keebler & Associates, LLP, Green Bay, Wisconsin; Richard A. Oshins, JD, LLM, AEP (Distinguished) is a Partner with Oshins & Associates, LLC, in Las Vegas, Nevada; Martin M. Shenkman, CPA, MBA, JD, PFS, AEP (Distinguished) is a Principal at Shenkman Law, PC, in Paramus, New Jersey; and Eido M. Walny, JD, EPLS, AEP, is with Walny Legal Group, LLC, in Fox Point, Wisconsin.

Thanks to the assistance of Michelle Ward of Keebler & Associates, LLP for bringing to our attention a recent case regarding bankruptcy exemption for inherited IRAs.

The 7th Circuit Court of Appeals has reversed a district court's ruling extending bankruptcy exemption to an inherited IRA (Download Case). In Clark, the Wisconsin district court had previously reversed the bankruptcy court's decision and allowed an inherited IRA to be exempt from the bankruptcy estate. The debtors, Mr. and Mrs. Clark, filed for chapter 7 bankruptcy in 2010. Mrs. Clark had inherited an IRA from her mother in 2001. Neither Mr. nor Mrs. Clark was retired. The debtors claimed the inherited IRA was exempt under Wisconsin law and 11 U.S.C. Sec. 522(b)(3)(C). The Court of Appeals (cases Nos. 12-1241 & 12-1255) stated that by the time the Clarks filed for bankruptcy, the money in the inherited IRA did not represent anyone's retirement funds and that to treat this account as exempt would be to shelter from creditors assets that can be freely used for current consumption. The Court further stated that an inherited IRA does not have the economic attributes of a retirement vehicle, because the money cannot be held in the account until the current owner's retirement.

Given this recent decision and the diversity of decisions on this topic, caution suggests having an IRA payable to a trust rather than to a beneficiary outright to strengthen creditor protection.

Keebler & Associates, LLP assisted the Law Firm of Kavesh, Minor & Otis in obtaining PLR 200537044, approving the IRA Inheritance Trust®, the use of a standalone trust as beneficiary of IRA assets for the purpose of ensuring the stretchout of RMDs and providing added protection of IRA assets.  For more information about the IRA Inheritance Trust®, click here.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  Connect with us on Facebook, Twitter or LinkedIn.

Thanks to generosity of Robert Keebler, CPA, MST, AEP (Distinguished) of Keebler & Associates, LLP, AICPA and Leimberg Information Services, we are pleased to provide to you two free podcasts to download on the subject of President Obama's 2014 Proposed Budget.

Obama's proposed budget will have a negative impact on the following planning:

1. The estate tax rate would increase to 45% from today’s 40% rate.
2. The gift tax exemption would be reduced to $1,000,000
3. The estate tax and GST exemptions would be reduced to $3,500,000
4. The GST period would be limited to 90 years from today’s unlimited period
   1. Current dynasty trust transactions would be grandfathered
5. The IDGT trust transactions will be eliminated on a prospective basis
   1. Current dynasty trust transactions would be grandfathered
   2. Additional sales would not be protected
6. The GRAT transaction will be eliminated on a prospective basis
   1. Ten year rule
   2. No zeroing out GRATs
7. A Buffet rule would impact income greater than $1,000,000
8. Itemized deductions would be reduced to a credit for those with income greater than $250,000
9. Carried Interests capital gain treatment would be eliminated
10. A special provision would eliminate the ability to retain more than approximately $3,400,000 in an IRA or pension plan.

The 90-year GST rule may require some thought and attention.  Recall that for pre-1986 GST trusts any contribution after the effective date eliminates grandfather status.  It may be prudent  to sever/decant/reform insurance and other trusts before the end of 2013 if this provision becomes law.

AICPA Podcast
"Robert Keebler on President Obama's 2014 Proposed Budget"
DOWNLOAD

LISI's 60-Second Planner Podcast
"Key Elements of the President's 2014 Budget"
DOWNLOAD

The podcasts above are the copyrighted materials of Robert S. Keebler, CPA, MST, AEP (Distinguished), AICPA and Leimberg Information Services, Inc. These are provided to you as a courtesy from the permission granted to The Ultimate Estate Planner, Inc.  Reproduction in any form or forwarding to any person prohibited without the express permission of AICPA and Leimberg Information Services, Inc.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  Connect with us on Facebook, Twitter or LinkedIn.

The Ultimate Estate Planner, Inc. is pleased to share with you a copy the article, "Tax Planning for the New 3.8-Percent Medicare Tax" by Robert S. Keebler, CPA, MST, AEP (Distinguished) found in the Family Tax Planning Forum that appeared in TAXES - The Tax Magazine®'s October 2012 edition.  The Health Care and Education Reconciliation Act of 2010 created a 3.8% tax, referred to as an Unearned Income Medicare Contribution Tax (UIMCT), on certain passive investment income of individuals, trusts and estates scheduled to begin in 2013. The attached article provides an overview of the new tax, explains how it is calculated and offers some planning strategies to reduce or eliminate exposure to this new tax.  Click here to read the full article.

This article is reprinted and redistributed with the publisher's permission from TAXES - The Tax Magazine®, a journal published by CCH, a Wolters Kluwer business. Copying or distribution of this article without the publisher's permission is prohibited. To subscribe to TAXES - The Tax Magazine® or other CCH Journals please call 800-449-8114 or visit cchgroup.com.

RELATED DOWNLOADS & ON-DEMAND PROGRAMS:

On-Demand 60-Minute Educational Programs The 3.8% Health Care Surtax and Its Impact on Trusts and Estates The 3.8% Health Care Surtax and Its Impact on Individuals
Understanding the 3.8% Health Care Surtax Chart
3.8% Surtax Checklist for Trust & Estates

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  Connect with us on Facebook, Twitter or LinkedIn.

November 6, 2012 may prove to be one of the most important election days in U.S. history, at least from a tax perspective. Regardless of who wins the Presidency and who controls the Senate and House, we are likely to see the first major changes to the U.S. Tax Code in over ten years.

Accordingly, there is no better time than immediately after the election to advise your clients and prospects on what important steps to take before the tax law changes in 2013.

That's why we're bringing together on November 7th - - the day after the election - - two of the sharpest minds in income and estate tax planning - - Robert S. Keebler, CPA, MST, AEP (Distinguished) and Martin M. Shenkman, J.D., CPA, MBA - - to evaluate the likely impact of the election on current and future tax laws and identify exactly what you should immediately advise your clients and prospects to do.

On this timely 90-minute teleconference, Bob and Marty will specifically address with you the following:

• Likely changes to the current Income Tax Laws:
  • Ordinary income tax rates
  • Capital gains tax rates
  • The tax benefit of certain deductions
  • The impact of the Alternative Minimum Tax (AMT)

• Likely changes to the current Estate & Gift Tax Laws:
  • The estate and gift tax exemption
  • The generation-skipping transfer (GST) tax exemption
  • The estate, gift and GST rate
  • Portability of the estate tax exemption
  • Valuation discounts
  • Restrictions to multi-generational dynasty trusts
  • Other restrictions to intra-family transfers

• Income Tax Actions to take before year-end:
  • Analyzing when to take deductions and losses
  • When to take income and harvest capital gains
  • Roth IRA conversions
  • Income shifting to junior generations

• Estate Planning Actions to take before year-end:
  • Annual exclusion gifts
  • Lifetime gift exemption gifts
  • Taxable gifts
  • Grantor Retained Annuity Trusts (GRATs)
  • Dynasty Trusts
  • Installment Sales to Dynasty Trusts
  • Family Limited Partnerships (FLPs) and Limited Liability Companies (LLCs)
  • Spousal Lifetime Access Trusts (SLATs)
  • Front-end loading Irrevocable Life Insurance Trusts (ILITs)
  • Forgiving intra-family installment notes

• And much, much more!

Whether you're a CPA, financial advisor, life insurance agent or estate planning attorney, you should be among the first estate planning professionals "in the know".

Join us on Wednesday, November 7th at 9am Pacific Time (12pm Eastern Time) for this very special 90-minute teleconference entitled, "November 7, 2012: The Day After - - A Tax Planning Guide to Surviving 2012, 2013 & Beyond".

Your registration includes: Participation on the teleconference (including a live Q&A session) that comes with handout materials, an audio recording of the teleconference and a Certificate of Completion.  You get all this for everyone in your office for one low price of just $149.

For more information and to register...

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  If you are interested in a personal consultation for your office regarding how to make your office more efficient and how to improve the productivity of your attorneys, staff and advisors, contact us today at 1-866-754-6477 to find out how you can receive a free 30 minutes consultation.  Connect with us on Facebook, Twitter or LinkedIn.

At The Ultimate Estate Planner, Inc. it's important to us to keep our customers and the rest of the estate planning community informed about very important and exciting updates as it happens.  A special thank you to Michelle Ward and Robert Keebler for this wonderful article featured on WealthManagement.com.

Roth IRA Conversion Recharacterization Permitted by Michelle L. Ward
Taxpayer relied on financial advisor’s advice

In Private Letter Ruling 201235030 (June 6, 2012), received by Keebler & Associates, the Internal Revenue Service granted the taxpayer an extension to recharacterize his 2009 Roth individual retirement account conversions.

Facts
In 2009, the taxpayer read articles and heard discussions describing the end of the $100,000 income limitation (which actually occurred in 2010) for converting to a Roth IRA and highlighting the benefits of performing such a conversion.  He came under the mistaken impression that the income limitation was eliminated in 2009, rather than in 2010.  Because the articles, generally, indicated that it was a good time to perform a conversion, due to the decline in the stock market, he decided to go forward with performing the Roth IRA conversions.

Also in 2009, before he performed the Roth conversions, the taxpayer consulted with his financial advisor, who was also his uncle, and discussed that he was considering performing a Roth IRA conversion.  The financial advisor submitted an affidavit along with the PLR request, in which he represented that he has been advising the taxpayer and the taxpayer’s wife since 1998, that in 2009 the taxpayer discussed with him the idea of a Roth conversion, that he never informed the taxpayer the $100,000 limitation still applied in 2009, that his failure to inform the taxpayer was an oversight on his part and that the taxpayer relied on the financial advisor to inform them if a Roth conversion was either inadvisable or not allowable.

The taxpayer prepares his and his wife’s tax return annually without the assistance of a paid preparer.  In 2009, he used software to prepare their income tax return, but due to a keystroke or entry error when completing the 2009 Form 1040, the Roth IRA conversion amounts he placed on line 15a didn’t carry over to line 15b.  He didn’t realize this error had occurred when he filed their tax return.  Because of this error, the taxpayer and his wife received an IRS Notice of Deficiency, increasing their income by the amount of the conversion.  Upon receipt of this Notice, the taxpayer contacted an attorney for assistance, and it was during these conversations with that the taxpayer first discovered that he had been ineligible to make the 2009 Roth conversions, because his 2009 income exceeded $100,000.

IRS Ruling
For tax years beginning before 2010, a taxpayer is eligible to rollover funds from a traditional IRA to a Roth IRA provided that his: (1) adjusted gross income (AGI) was no more than $100,000, and (2) filing status wasn’t “married filing separately”.

To the extent that a taxpayer converted his traditional IRA to a Roth IRA and later found out that his AGI exceeded $100,000, the taxpayer could elect to recharacterize (that is, undo) the conversion.  However, the recharacterization must have been completed on or before the due date of the federal income tax return (including extensions) for the year of conversion (that is, no later than October 15th would be constrained to the original conversion amount.

Notwithstanding the Oct. 15th deadline, under Treasury Regulations Section 301.9100-1(c), the IRS may grant a reasonable extension of time fixed by regulation, a revenue ruling, a revenue procedure, a notice or an announcement for making an election, which includes a Roth IRA recharacterization.

Treas. Regs. Section 301.9100-3 provides that applications for relief will be granted when the taxpayer provides sufficient evidence to establish that: (1) the taxpayer acted reasonably and in good faith; and (2) granting relief wouldn’t prejudice the interests of the government.  The regulations provide that a taxpayer will be deemed to have acted reasonably and in good faith if, among other factors, the taxpayer reasonably relied on a qualified tax professional, and the tax professional failed to make, or advise the taxpayer to make, the election.

In this case, the IRS found that the information presented and documentation submitted by the taxpayer was consistent with his assertion that his failure to elect to recharacterize the Roth IRA on or before the due date was caused by his lack of awareness of the necessity of making an election, as a result of his reliance on his financial advisor.

Lessons Learned
Although one should never depend upon Treas. Regs. Section 301.9100-3 relief, this PLR provides some insight as to when such relief can be granted.  It’s also a good reminder of the power of the recharacterization provisions.  Although, in this instance, the recharacterization provisions applied when the taxpayer's modified AGI exceeded $100,000, there’s nothing to prevent a recharacterization if the Roth IRA falls in value after the conversion or if the taxpayer's financial circumstances change significantly. 

The primary benefit of recharacterizations is that the taxpayer can assess the post-conversion returns and determine if the conversion was worthwhile in the first place.  For example, let’s assume a taxpayer converts $100,000 to a Roth IRA in 2012.  Now let’s assume that the value of the Roth IRA is $80,000 in March 2013.  In this case, the taxpayer would simply recharacterize the conversion by moving the entire $80,000 Roth IRA back to a traditional IRA on or before the time he files his 2012 individual income tax return.  The effect of the recharacterization is that the taxpayer won’t be taxed on any of the $100,000 original conversion, because he recharacterized the entire amount back to a traditional IRA.

The 2012 tax year is the perfect time to take advantage of converting to a Roth IRA before income tax rates go up in 2013.  In many cases, taxpayers can easily achieve a “heads I win, tails I tie” situation, especially those who have sufficient wherewithal outside of their IRAs to pay the income tax liability on a Roth IRA conversion.  In most cases, all post-conversion income and growth can be sheltered from future income tax, while any post-conversion losses can be made less painful by recharacterizing the prior conversion.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  If you are interested in a personal consultation for your office regarding how to make your office more efficient and how to improve the productivity of your attorneys, staff and advisors, contact us today at 1-866-754-6477 to find out how you can receive a free 30 minutes consultation.  Connect with us on Facebook, Twitter or LinkedIn.

Photo Credit: under30ceo.com
Source: WealthManagement.com

Join us next Thursday, September 6th for a special 60-minute teleconference with nationally renowned CPA, Robert S. Keebler, on the topic of Portability and the New Form 706.  For more information and to register, click here.

Last Friday, the Internal Revenue Service released a draft of the new Form 706.  For the first time, the form addresses the issue of portability of a deceased spouse's unused estate and gift tax exclusion amount by providing an option for the executor to opt out of electing portability of the unused portion.

Under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, a surviving spouse can increase his or her applicable exclusion amount by the amount of the unused exclusion amount of the deceased spouse, provided that the deceased spouse died after 2010. This provision is currently scheduled to expire after on December 31st of this year.  This election is made by the executor of the deceased spouse’s estate. Form 706 must be filed to make the election, and even estates that would not otherwise be required to file Form 706 must file in order to make the election.
 
Because filing Form 706, by default, causes the election to be made, the draft Form 706 provides a mechanism for estates that are required to file because the value of the gross estate exceeds the applicable exclusion amount or for another reason to opt out of the election.

Again, we will be covering the new Portability Rules and this new Form 706 on our teleconference next Thursday, so be sure to register right away!

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  If you are interested in a personal consultation for your office regarding how to make your office more efficient and how to improve the productivity of your attorneys, staff and advisors, contact us today at 1-866-754-6477 to find out how you can receive a free 30 minutes consultation.  Connect with us on Facebook, Twitter or LinkedIn.

Photo Credit: blog.aicpa.org
Source: Journal of Accountancy

Reproduced with Permission by and Courtesy of Leimberg Information Services, Inc. (LISI).  For information about how to subscribe to LISI, click here.

“For tax years beginning after 2012, new Internal Revenue Code (IRC) section 1411 imposes a 3.8 percent surtax on certain passive investment income of individuals and of trusts and estates based on a mathematical formula. For taxpayers to be able to plan around the tax they must first understand what income it applies to and how the tax is calculated.”

Now, Bob Keebler provides members with a detailed analysis of the 3.8% Medicare surtax.

RELEATED FREE DOWNLOADS:

Understanding the 3.8% Health Care Surtax Chart
3.8% Surtax Checklist for Trust & Estates
You may also be interested in our upcoming educational teleconferences on the 3.8% Health Care Surtax.  If you would like more information, contact us at 1-866-754-6477 or check our Upcoming Teleconferences page.

EXECUTIVE SUMMARY: For tax years beginning after 2012, new Internal Revenue Code (IRC) section 1411 imposes a 3.8 percent surtax on certain passive investment income of individuals and of trusts and estates based on a mathematical formula. For taxpayers to be able to plan around the tax they must first understand what income it applies to and how the tax is calculated.

COMMENT:

Application of Surtax to Individuals
For individuals, the amount subject to the tax is the lesser of (1) net investment income (NII) or (2) the excess of a taxpayer's modified adjusted gross income (MAGI) over an applicable threshold amount. Let's first define each component of the formula.

Net Investment Income
This is investment income reduced by any deductions properly allocable to such income. For purposes of the surtax, investment income includes:

• Dividends
• Rents
• Interest
• Capital Gains
• Royalties
• Passive activity income

The types of income that is excluded from net investment income are:

• Self-employment income
• Active trade or business income
• Gain on the sale of an active   interest in partnership or S-Corp
• IRA or qualified plan distributions
• Trusts for charity (except CLTs)
• Non-resident aliens

The active trade or business exclusion means that dividends, rents, interest, capital gains, annuities and royalties are not treated as NII to the extent they are derived from an active trade or business. Thus, if a taxpayer is not engaged in a passive activity business, NII includes only non-business income from dividends, rents, interest, capital gains, annuities and royalties.  No business income is included. If the taxpayer is engaged in a passive activity business, however, NII includes all the items listed above plus income from the passive activity.

The charitable trust exception applies to charitable remainder trusts exempt from tax under IRC section 664, trusts exempt from tax under IRC section 501(c) and trusts in which all of the unexpired interests are devoted to charity, but not to charitable lead trusts.

MAGI
This is simply the amount reported at the bottom of page 1 of Form 1040 (AGI) plus the net amount excluded as foreign earned income  under IRC section 911(a)(1). Since the foreign earned income exclusion applies only to U.S. citizens or residents who live abroad, MAGI and AGI will almost always be the same. MAGI is basically total taxable income and does not include tax-exempt income such as interest on tax-exempt bonds, excluded gain on the sale of the principal residence or veteran's benefits. Required minimum distributions from a traditional IRA or 401(k) plan and income recognized on a Roth IRA conversion are included in MAGI, but non-taxable distributions from a Roth IRA are not.

Note that the surtax doesn't necessarily apply only to taxpayers with large amounts of taxable income.  Because the calculation is based on MAGI, which is above-the line income on Form 1040, taxpayers with more modest amounts of taxable income could be affected if they have large below-the-line deductions on Schedule A. Finally, do not confuse the definition of MAGI used here with the definition of MAGI used to determine how much of an individual's contribution to a traditional IRA is deductible. Although the IRS gave the two amounts the same name, the calculations are very different.

Threshold Amounts
The applicable threshold amounts for individuals vary depending on filing status and are shown below:

          Married Taxpayers, Filing Jointly                       $250,000   

          Married Taxpayers, Filing Separately               $125,000

          All other individual taxpayers                             $200,000

Application of the Surtax to Trusts and Estates
The annual surtax payable by a trust or estate is 3.8 percent of the lesser of (1) undistributed net investment income or (2) the excess of AGI over the amount at which the top income tax bracket for trusts and estates begins. The highest bracket starts at $11,200 for 2010, but will be indexed for inflation.

The surtax presumably will not apply to grantor trusts or to simple trusts. With a grantor trust, the grantor is treated as the owner and all items of trust income are reported on the grantor's individual tax return. Thus, the trust's items of income would be added to the grantor's items of income and any surtax would be calculated on the grantor's return. Simple trusts require all income to be distributed currently so undistributed net investment income would ordinarily be zero.

Planning for the Surtax
Before examining specific strategies for reducing or eliminating the surtax payable, some general observations may be helpful. First, assuming a taxpayer is subject to the surtax in the first place, reducing NII will always reduce the amount of surtax payable dollar for dollar. The reason is that any reduction in NII also reduces MAGI.

Example 1: Kay, a single taxpayer, has $190,000 of salary income and $75,000 of capital gains. She will be subject to the surtax on the lesser of NII ($75,000) or the excess of MAGI over the $200,000 threshold amount for single taxpayers ($65,000), so the amount subject to the surtax is $65,000. If Kay recognizes $30,000 of capital losses, reducing her NII to $45,000, she also reduces the amount subject to the surtax by $30,000. The base for calculating the surtax is now the lesser of $45,000 or ($235,000 - $200,000), or $35,000. The reason for this result is that reducing NII also reduces MAGI.

The same cannot be said for decreasing MAGI, however. If the excess of MAGI over the threshold amount initially exceeds the amount of NII, non-NII reductions in MAGI will not reduce the surtax until the excess amount and NII are equal. Consider the following example.

Example 2: Tom, a single taxpayer, has MAGI of $500,000, including $100,000 of NII. Recall that the threshold amount for a single taxpayer is $200,000. Thus, Tom's excess MAGI over the threshold amount is $300,000. Since his NII is less than this amount, he will initially be subject to the surtax on $100,000. Suppose that Tom can reduce non-NII MAGI by $75,000. This reduces his excess amount to $225,000, but since NII is still lower the reduction makes no difference. If Tom can reduce non-NII MAGI by more than $200,000, though, he will reduce the amount subject to the surtax dollar for dollar. With a reduction of $300,000, the amount subject to the surtax will drop to $0 even though Tom still has $100,000 of NII.

The point to note here is that if taxpayers are trying to reduce exposure to the surtax after 2012, they can always do so by using a planning strategy that reduces NII. If they are using a strategy to reduce non-NII MAGI, however, it will only help to the extent it reduces the MAGI excess amount below the amount of NII. With that caveat in mind, let us now turn to some specific strategies for eliminating surtax.

Specific Strategies
As noted above, there are two kinds of strategies for minimizing exposure to the surtax: (1) strategies that reduce NII and (2) strategies that reduce MAGI. To be more precise we should perhaps say (1) strategies that reduce both NII and MAGI, because any reduction in NII will produce a corresponding reduction in the MAGI excess amount and (2) strategies that reduce only MAGI. Nevertheless we will analyze the strategies according to their main effect.

Reducing Net Investment Income (NII)

Tax Exempt Bonds
While interest on corporate bonds is NII, interest on tax exempt bonds is not. Thus, for affected taxpayers, the surtax can clearly be reduced by switching from corporate bonds to tax exempt bonds. But is this always a good idea? The bottom line on taxable bond investments is after-tax return.

Tax Deferred Annuities
This strategy can reduce the surtax by making favorable changes in the timing of NII and MAGI. For example, if a taxpayer has NII and MAGI above the threshold amount in 2013 but expects to have much lower income later when she retires, a purchasing a deferred annuity can move NII and MAGI to years when they won't produce any surtax.

Life Insurance
A similar income smoothing result can be produced with a whole life insurance policy. By purchasing the policy, the taxpayer can reallocate money from assets producing current NII and/or MAGI to assets that are creating neither. The taxpayer could then withdraw basis from the policy in lower income years.

Rental Real Estate
As its name indicates, NII includes only net investment income. This means that investment losses can not only reduce investment income from an activity, but may even create a net loss that can be used to offset investment income from other activities. For example, depreciation deductions on rental real estate might exceed rental income. If so, the net loss can be used to offset other investment income like interest.

Oil and Gas Investments
If a taxpayer has particularly high income (and surtax) in a given year, the intangible drilling costs (IDCs) associated with oil and gas investments can produce a large current deduction. This deduction may be as much as 80% of the amount invested in a well.

Choice of Accounting Year for Trusts and Estates
The surtax applies to tax years ending after December 31, 2012. This means that if a trust or estate can choose between a tax year beginning in late 2012 rather than early 2013 it can realize significant tax savings.

Timing of Estate and Trust Distributions
Recall that for trusts and estates, the surtax applies to the lesser of (1) undistributed net investment income or (2) the excess of AGI over the threshold amount (currently $11,200). Given the low threshold amount, most NII of a trust or estate will be subject to the surtax unless it is distributed. If the beneficiaries would not be subject to the surtax on distributions, surtax could be saved by distributing enough of the net income to reduce undistributed income below $11,200.

Reducing MAGI
The key strategies for reducing MAGI are (1) Roth IRA conversions, (2) charitable remainder trusts (CRTs), (3) charitable lead trusts (CLTs), (4) installment sales and (5) above-the line deductions.

Roth IRA Conversions
The MAGI rules for IRAs are as follows:

1. Distributions from traditional IRAs are included in MAGI;
2. Income from Roth IRA conversions is included in MAGI; but
3. Distributions from Roth IRAs are not included in MAGI.

This means that taxpayers who would otherwise be subject to the surtax on distributions from their traditional IRAs can completely avoid the tax by doing a Roth IRA conversion before 2013.

Before deciding to do a current Roth conversion, however, taxpayers should do a comprehensive mathematical analysis to make sure it provides an overall benefit. The most important factor in this analysis is a comparison of the income tax rate on a conversion with the expected income tax rate on distributions. If the tax rate on the conversion is lower than the expected tax rate on distributions, the conversion will produce a better overall tax result. If the tax rate is expected to be lower at the time of distribution, however, it may be better not to convert.

The surtax and scheduled increase in rates for 2011 make it much more likely that a high income taxpayer will have a lower rate for a 2010 conversion than she would have on later distributions from a traditional IRA. For such taxpayers, the difference in tax rates between converting to a Roth IRA in 2010 and paying income tax plus surtax on traditional IRA distributions in 2013 and later years could be as much as 8.4% (39.6% + 3.8%) - 35%. Although the difference is less dramatic, the tax rate on a 2011 or 2012 conversion would still be 3.8 percent lower than the rate on distributions for top bracket taxpayers.

There are several other factors that weigh in favor of doing a Roth conversion. One is having funds outside the traditional IRA that can be used to pay the tax on the conversion. Paying the tax with outside funds has the same effect as being able to get more assets into the IRA and significantly increases the economic benefit.

Another favorable factor for taxpayers who don't need to live on IRA distributions is that unlike a traditional IRA, there are no required distributions from a Roth IRA. This allows more money to stay in the IRA to grow tax-deferred for heirs and increases the amount that can be accumulated. Finally, a Roth IRA gives a taxpayer the ability to take early distributions of contributions without paying the 10 percent penalty applicable to traditional IRAs. 

Charitable Remainder Trusts
These trusts pay a lead annuity or unitrust interest to the grantor or another non-charitable beneficiary, with the remainder interest passing to charity at the end of the trust term. An annuity interest is payment of a fixed percentage of the initial value of the trust assets each year. This means that the payments are the same each year. By contrast, a unitrust interest is payment of a fixed percentage of the trust assets re-determined each year to reflect changes in the value of the trust assets so that payments vary every year. Charitable remainder trusts (CRTs) that pay an annuity to the lead beneficiary are called charitable remainder annuity trusts (CRATs) and charitable remainder trusts that pay a unitrust amount are referred to as charitable remainder unitrusts (CRUTs).

The surtax does not apply to CRTs (either CRATs or CRUTs) because they are exempt from tax under I.R.C. section 664(c). This means that if a taxpayer contributed appreciated capital gain property to a CRT, the trust could sell the property without paying any surtax. Moreover, the gain would have no immediate effect on the grantor's MAGI. Rather, the taxpayer would have no MAGI until he received annuity or unitrust payments from the trust. This might enable the taxpayer to spread out MAGI and avoid having it exceed the threshold amount in any given year. The trade-off for this planning advantage is that the charity must be given a remainder interest with a value equal to at least 10 percent of the present value of the property transferred to the trust. The grantor receives an income tax deduction for the gift, however, reducing the cost of the charitable contribution.

Charitable Lead Trusts
Charitable lead trusts (CLTs) could be thought of as charitable remainder trusts in reverse. Instead of having non-charitable lead beneficiaries receiving payments for a period of time and charitable remainder beneficiaries, a CLAT has charitable lead beneficiaries with the remainder interest passing to non-charitable beneficiaries, typically the  grantor's heirs. Charitable lead trusts are almost invariably charitable lead annuity trusts (CLATs) rather that charitable lead unitrusts (CLUTs).

It is important to distinguish between two types of CLATs--grantor CLATs and non-grantor CLATs. In a grantor CLAT, the grantor is treated as the owner of the trust under the grantor trust rules and all items of trust income are reported on the grantor's individual tax return. The grantor receives a charitable deduction for the present value of the charity's lead interest when the trust is created but must pay the income tax on all the trust's income. In a non-grantor CLAT, the trust pays tax on its own income but receives a charitable deduction as it makes its annual annuity payments to the charitable lead beneficiary.

Grantor CLATs do not help with the surtax because all the trust income is taxed to the grantor, but non-grantor CLATs may be useful. Unlike CRTs, charitable lead annuity trusts are not exempt from the surtax, but they can use the charitable deductions they receive for the annuity payments they make to charity to offset any income.

Installment Sales
These can be used to spread out net investment income and MAGI in much the same manner as a charitable remainder trust. They may enable a taxpayer to avoid surtax exposure in the year of sale and in subsequent years.

Above-the-Line Deductions
Deductions that can be claimed on page one of Form 1040 reduce MAGI. Two of the most important are contributions to qualified plans and traditional IRAs and charitable contributions.

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Bob Keebler

CITE AS: LISI Income Tax Planning Newsletter #28, (July 30, 2012) at www.leimbergservices.com. Copyright 2012 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  Connect with us on Facebook, Twitter or LinkedIn.

Source: Leimberg Information Services, Inc. & Robert S. Keebler, CPA, MST, AEP

 

The Supreme Court’s decision upholding the Affordable Care Act confirmed that taxpayers whose income exceeds a threshold amount will be subject to a 3.8% Medicare surtax on net investment income, effectively raising their marginal income tax rate. However, whether the Bush era tax cuts will be extended and, if so, for whom, remains an open question. In light of this uncertainty, CPAs may want to start planning for possible 2013 tax increases now, particularly for clients who will benefit from transferring assets to family members, decisions that can take time to make. Download a free Medicare surtax chart from Robert Keebler, CPA, and listen to his recent podcast on how to plan for the Medicare surtax below.

Robert S. Keebler, CPA, MST, DEP, Partner, Keebler & Associates, LLP. Bob is a 2007 recipient of the prestigious Distinguished Estate Planners award from the National Association of Estate Planning counsels. From 2003 to 2006, Bob was named by CPA Magazine as one of the top 100 most influential practitioners in the United States. He is the past Editor-in-Chief of CCH's magazine, Journal of Retirement Planning and a member of CCH's Financial and Estate Planning Advisory Board. His practice includes family wealth transfer and preservation planning, charitable giving, retirement distribution planning, and estate administration.  

This audio webcast was originally recorded June 29, 2012.

Transcript:

On behalf of the PFP Division of the AICPA, this is Bob Keebler, bringing you planning strategies in the wake of the Supreme Court's decision on health care.

Earlier today the Supreme Court ruled that the health care bill was constitutional.  This holding means that beginning January 1st, 2013, a Medicare payroll tax of 0.9% will be imposed on individuals with income exceeding $200,000 and married couples with income exceeding $250,000.  Also beginning in January is a 3.8% surtax which applies to the lesser of net investment income or the amount by which AGI exceeds $200,000 for individuals and $250,000 for married couples.  To reiterate, the surtax applies to all investment income if the taxpayer's AGI is above the threshold.

The mandate or penalty is scheduled to take effect January 1st, 2014.  It will impose an additional tax on those who cannot secure insurance.  Beginning in 2014, the annual penalty will be $95 or 1% of income, whichever is greater.  This will eventually rise to $695 or 2.5% of income by 2016.  Families will have a maximum flat penalty of $2,085, but will still owe 2.5% of income if that is greater.

In 2012, all W-2s will include the value of health insurance provided to employees.  Effective in 2011, the penalty on non-qualified distributions from HSAs will be doubled to 20%.  For 2013, the itemized deduction floor on medical expenses will increase to 10% of AGI.  Beginning in 2018, the Cadillac tax will be implemented.  This will be a 40% excise tax on the portion of health care plans that exceed $10,200 for individuals or $27,500 for families.

Beginning in 2014, a refundable health tax credit will be available to help individuals with low income to purchase coverage.  Also beginning in 2014, a nondeductible fee of $2,000 per employee will be imposed on business which do not provide adequate coverage.  The first 50 employees are not counted under this threshold.

Also, recognizing there's a lot to learn, Speaker of the House John Boehner has promised to repeal what's left of Obamacare so that all these new rules we're learning will never be implemented.

Perhaps the most important part of the Court's decision is that the 3.8% Medicare surtax will stand.  This means beginning on January 1st, 2013, a new 3.8% Medicare surtax will apply to all taxpayers whose income exceeds a threshold amount.  This new surtax will, in essence, raise the marginal income tax rate for affected taxpayers.  For example, beginning in 2013, a person in the 39.6% bracket -- i.e., the highest marginal tax rate that could be in effect in 2013 -- would increase to 43.4%.  So what we're looking at basically across the board is an increase on investment income of 3.8%.

Now, there's a little bit of a calculation that goes into this.  The new Medicare surtax is equal to 3.8% times the lesser of the following: net investment income or the excess of modified adjusted gross income for such a taxable year over a threshold amount.  Now, let's talk about what those threshold amounts are.  Threshold amount is going to be $250,000 for married couples and $200,000 for individuals.  But for estates and trusts, the threshold amount will be right around $12,000.  So for estates and trusts, immediate steps are needed to plan for this.

So the new Medicare surtax is equal to 3.8% times the lesser of, in the context of an estate or trust, undistributed net investment income for such taxable year or the excess of adjusted gross income for such taxable year over the dollar amount of which the highest bracket begins.  So basically, once you hit $12,000 of income in a trust, give or take a little bit there, you're going to be subject to a 3.8% surtax.  So especially for trusts that are accumulating prince -- principal and income, and they're not making distributions, those trusts are going to be hit with the 3.8% surtax.

One very critical thing for most of us to pay attention to is the year-end we choose for individuals that died in 2011 or 2012.  By selecting the right year end we may be able to stretch out the rule so that the 3.8% surtax doesn't apply until December 1st, 2013.  You would do that by picking a November 30th, 2012, year end, and then the next year starts on January 1st, 2012, and this tax only applies to years that begin on or after January 1st, 2013.  So we can stretch that out a little bit.

Now, there's three critical terms we need to understand when we're working with the 3.8% Medicare surtax: net investment income, the threshold amount and modified adjusted gross income.  So those are the keys.  Now, net investment income is defined as interest, dividends, annuities, rents, royalties, income derived from a passive activity and net capital gains.  It doesn't include wages.  It doesn't include distributions from IRAs and qualified plans.  It doesn't include self-employment income or the gain on an active sale of a trade or business.  There'll be a lot more to learn, but this is a quick overview.

Now, I want to come back to these threshold amounts.  Basically, in 2013, the threshold amount for single taxpayers will be $200,000, married 250, estates and trusts $11,650.  The key is modified adjusted gross income.  Basically, the front page of the return is going to give us our modified adjusted gross income.  Modified adjusted gross income means adjusted gross income, basically line 37 plus that foreign earned income that's been excluded from income, and that's going to be our adjustment.

Okay, now, there's a number of examples.  I've provided to everyone a chart which is called Understanding the Health Care Surtax.  From the front, we go through the law, but on the back we have 23 separate examples to help you get your arms around how this works.  I would encourage all of you to study that chart.  It's a quick read.  Within an hour, I think you'll have a real good feel for how this is going to apply in your practice.  Let me give you a couple of quick examples, just so you can start to think like this.

John, a single taxpayer, has $100,000 of salary and $50,000 of net investment income for the year.  A 3.8% surtax would not apply, because his modified adjusted gross income is less than $200,000.  Now, Linda, a single taxpayer, has $225,000 of net investment income, no other sources of income.  The 3.8% surtax will only apply to $25,000, so $200,000 of threshold, $225,000 of net investment income minus the $200,000 threshold means that $25,000 will be exposed to the 3.8% tax.

Terry and Tina, married filing jointly, have $300,000 of salaries and absolutely no investment income.  The 3.8% surtax will not apply to them because they have no investment income.  Now, same case, except Peter and Paula have $400,000 of salaries and $50,000 of net investment income.  They're going to pay the 3.8% surtax on $50,000.  So basically, because they're over the threshold amount, they have to pay the 3.8% surtax on their investment income.

So this is going to affect a lot of taxpayers.  It's also going to affect many estates and trusts, okay?  So that's something we have to understand.  Now, the strategies planning around the surtax, municipal bonds, tax-deferred annuities for people that are still working, life insurance, rental real estate, where you have depreciation.  Life insurance is going to work because life insurance is tax-free when you die, obviously.  Very effective for bypass trusts.  Life insurance also works because I can borrow my principal and not have to pay tax.  Oil and gas investments will continue to work because of the large IDC deductions you receive up front and because you have depletion allowances along the way.  Basically, it's our tried and true tax shelters that are going to continue to work.

But we also want to focus on the choice of accounting years for estates and trusts, and very much we're going to be focused on the timing of estate and trust distributions and how that will play into the surtax.  So when you work through this, there is a lot to know.  And basically we're all -- every time a client asks you a question on a going-forward basis, you're going to have to measure that question not only from an income tax perspective, but looking at the AMT results, and then finally looking at what's going to happen under this new surtax.  So again, a lot to cover.  And let's jump back in, though, and let's look at some strategies.

Okay, so one of my biggest strategies is going to be life insurance.  Another big strategy will be what we call the leapfrog annuity.  Using annuities to shelter income -- say, for a surgeon that's 55 years old, he's still working, but he has a lot of conservative investments, he might use an annuity to leapfrog until he retires.  Transfer that income out over his wages so that all that ex-passive income subject to a surtax does not hit his tax return until he's fully retired and no longer has those wages.

When we're planning around to reduce modified adjusted gross income, not just investment income.  Our Roth conversions will continue to be very popular.  Charitable remainder trusts will -- there will be a renaissance in charitable remainder trusts as people sell positions and securities because they're not going to want to sell all in one year, or they might drop it into a charitable remainder trust and then take distributions out over a 15- or 20-year period of time.

I think non-grantor charitable remainder trusts will also have some efficacy, and installment sales will come back more than we've seen in the past, because instead of selling a building, an apartment building in one year and having a $2 million gain, I might spread that gain out over ten or 15 years through an installment note.

One of the things on the Roth IRA we have to consider is Roth IRAs will probably be looked at as a way around the surtax, because they will reduce modified adjusted gross income.  So they're going to put a dent in modified adjusted gross income.  I think there's a lot to cover here, but we really want to take a look at how Roth IRAs play into your wealthier clients that are going to have major-league surtax problems.

Okay, now again, charitable remainder trusts, why would we do that?  We would to the charitable remainder trusts because we will avoid recognizing the income of one year, but maybe spread it over a ten- or 15-year term for the whole entire charitable remainder trust.  When you run the math, typically it's hard to make a charitable remainder trust work without a charitable intention.  This may bring that much closer together as a decision.  When you're designing your charitable trusts, remember, you can do these annuity trusts or charitable remainder unit trusts.

So there's truly a lot to cover, okay?  There's truly a lot to cover.  I think we're just starting here, and I'm hoping that my chart will help all of you get your arms around this.  Talk to your clients about this.  You -- We are at a tremendous place in our history, where really in the next six months you can probably make more impact than you ever could in your career.

On behalf of the PFP Division of the AICPA, this has been Bob Keebler, and thank you for joining us.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  If you are interested in a personal consultation for your office regarding how to make your office more efficient and how to improve the productivity of your attorneys, staff and advisors, contact us today at 1-866-754-6477 to find out how you can receive a free 30 minutes consultation.  Connect with us on Facebook, Twitter or LinkedIn.

Source: Keebler & Associates, LLP, Robert S. Keebler, CPA, MST, AEP (Distinguished)