for producer and professional advisor use only. not for use with the public. the american taxpayer...

For Producer And Professional Advisor Use Only. Not For Use With The Public.

The American Taxpayer Relief Act

(ATRA) of 2012Al Kingan, JD, LLM, CLU, ChFCAVP, Estate and Business Planning

Estate & Business Planning

CRN201502-169437


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Disclaimer

The information contained in this presentation is being provided with the understanding that it is not intended to be interpreted as specific legal or tax advice. Neither MassMutual nor any of its employees or representatives are authorized to give legal or tax advice. The information provided herein may not be relied on for purposes of avoiding any federal tax penalties. Individuals are encouraged to seek the guidance of their own legal or tax counsel. Any individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.


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New Tax Law Summary Fiscal Cliff Averted? Planning strategies

Copyright AALU 2012 All Rights Reserved

Main Topics of the Day:


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Summary of Key Provisions of New Tax Law

Estate, gift and generation-skipping tax exemptions and rates* Exemptions: $5,000,000 indexed from 2010 ($5,250,000 for 2013) Flat tax rate above exemption amount: 40%

Permanent reunification of estate, gift and generation-skipping transfer tax system

Portability made permanent

* Cost of these provisions is estimated to be $396.068 billion over 10 years by Congressional Budget Office (CBO) scoring of this tax act. All estimates on this and later slides are from the CBO scoring of ATRA 2012 and appear in RED.


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Summary of Key Provisions of New Tax Law Other key provisions - Permanent

Extension of 10% (lowest) income tax bracket $442.641 billion/10yrs Extension of lower tax brackets (25%, 28%, 33% and 35%) for

taxpayers with income at or below: $319.711 billion/10yrs $400,000 - single filers $425,000 – head of household $450,000 – married filing jointly

Extension of 15% (and lower) capital gains and dividend rates (qualified dividends only) for taxpayers with income at or below:

$400,000 - single filers $289.920 billion/10yrs $425,000 – head of household $450,000 – married filing jointly

For taxpayers with income above the threshold amount, both dividends and capital gains will be taxed at 20%


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Summary of Key Provisions of New Tax Law Other key provisions – Permanent

Repeal of the personal exemption phase-out (“PEP”) and itemized deduction phase-out (“Pease”) on incomes at or below:

$250,000 - single filers PEP and Pease: $10.514 billion/10yrs $275,000 – head of household $300,000 – married filing jointly

Pease phase-out is the lesser of 3% of excess over threshold amount, or 80% of allowable deductions (no reduction of medical, investment interest or casualty/theft and gambling losses)

PEP phase-out is calculated at 2% for each $2,500 that taxpayer’s adjusted gross income exceeds threshold amount

Example: Jim and Sally are married and earn $350,000

Pease Adj: ($350,000 - $300,000) x 3% = $1,500 reduction PEP Adj: ($350,000 - $300,000) / $2,500 = 20 * 2% =

= 40% reduction in allowable personal exemption


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Alternative Minimum Tax $1,815.6 billion/10yrs

Permanent exemption increase for 2012 as follows: $50,600 - single filers (from $33,750 current law) $78,750 - married filing jointly (from $45,000)

Phase-out of exemption

Phase-out formula: Exemption is reduced by 25% of amount that taxpayer’s AMT income exceeds:

$112,500 - single filers $150,000 - married filing jointly

Now allows non-refundable credits against the AMT

Both exemption and phase-out threshold now indexed for inflation

Future inflation indexing eliminates yearly need for “patches”


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IRA Charitable Rollover – 2 year ext. thru 2013 $1.280 billion/10yrs Over 70½, Tax free distribution from IRA to qualified charity of up

to $100,000 Meets RMD requirement Transition rules:

Rollover to charity during January 2013 can count as a 2012 distribution

Taxpayers who took distribution in December 2012 can make a cash gift to qualified charity during January 2013 that will be treated as an eligible 2012 charitable rollover

Itemized deduction for state and local sales taxes in lieu of state and local income taxes – also only 2 years $5.538 billion/10yrs

Mainly helps those with large ticket purchases or who live in states with no income tax


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Roth conversions for retirement plans $12.186 billion/10yrs revenue Applies to 401(k), 403(b), or 457(b) government plans Any amount in a non-Roth account can be converted to a Roth

account in the same plan Prior law permitted conversion only as to amounts eligible to be

withdrawn from plan (usually participant over 59½ or separated from service)

New law permits conversion whether or not eligible for distribution


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Misc. Provisions - permanent Extend marriage penalty relief – 15% bracket, standard deduction and EITC

$84.630 billion/10yrs Child tax credit (some refundability) $354.493 billion/10yrs Adoption assistance/credits $5.580 billion/10yrs Expanded dependent care credit $1.791 billion/10yrs Student loan interest deduction $9.676 billion/10yrs Employer provided education benefits $11.477 billion/10yrs

Misc. – temporary Child credit (expanded refundability) – 5 years $50.518 billion/10yrs American Opportunity Tuition Tax Credits – 5 years $67.280 billion/10yrs College tuition (above line deduction) – thru 2013 $1.706 billion/10yrs Mortgage insurance treated as mortgage interest - 1 yr $1.297 billion/10yrs Energy efficient home and appliance credit – thru 2013 - 2 years

$2.446 billion/10yrs


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Misc. Business Provisions Bonus depreciation – thru 2013 (2014 for certain “longer lived” and

transportation assets) $4.956 billion/10yrs R & D credit– thru 2013 (2 yrs) $14.324 billion/10yrs 15 year straight-line cost recovery for qualified leasehold improvements,

qualified restaurant buildings and improvements and qualified retail improvements – extended thru 2013 (2 yrs) $3.717 billion/10yrs

Enhanced Sec. 179 expensing – thru 2013 (2 yrs) $2.352 billion/10yrs Full/partial exclusion gain on sale of certain small business stock held for

5 years – applies to stock acquired by 12/31/2013 $954 million/10yrs Reduction in holding period of S Corp Stock to 5 years to avoid Built in

Gain Tax – applies to asset sales during 2012/13 $256 million/10yrs


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Financial Impact of New Tax Law

10 year cost estimated at over $3.96 trillion Current debt ceiling limit is $16.394 trillion Yet:

Some Congressional leaders have taken credit for raising $620 billion in new revenue through passage of ATRA 2012 Note the cited $620 billion figure is the difference between what

the tax law cost and what it would have cost if all Bush-era and 2010 Tax Act provisions had been permanently extended


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Not Impacted By New Tax Law

Social Security tax holiday is gone! Base Social Security withholding tax back to 6.2% (from

4.2%) for employees Self-employment tax back to 12.4% from 10.4% 2013 FICA tax base earnings limit: $113.700

Patient Protection and Affordable Care Act of 2010 adds 0.90% surtax employee’s portion of FICA Medicare tax for income over: $200,000 – Single taxpayers $250,000 – Married couples


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Higher Medicare Payroll Tax - .90%

FICA 2011 2012 2013 Cap

Medicare (HI)

1.45% 1.45% 2.35%1 None

Social Security (OASDI)

4.20%

($4,486)

4.20%

($4,624)

6.20%

($7,049)

’11- $106,800

’12- $110,100

’13- $113,700

Total 5.65% 5.65% 8.55% Blended

1 Patient Protection and Affordable Care Act adds 0.90 percent to employee portion:

a. Single individuals earning more than $200,000 per year and

b. Married couples earning more than $250,000 per year

Remember: Vested Deferred Compensation is subject to FICA, including additional .90% Medicare Tax


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Not Impacted By New Tax Law

Medicare Tax Extended to Unearned Income in 2013 3.8% surtax on unearned income

Interest Dividends Capital Gains Passive income Rental income Annuity payments (taxable portion)

Applies to Modified Adjusted Gross Income (MAGI) above: $200,000 (Single) $250,000 (Married filing joint) $11,950 (Estates and Trusts)

Applies to lesser of : Net investment income Total income over threshold

Not indexed for inflation


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Medicare Tax Expanded

“Unearned Income” Yes NoInterest/Dividends X

Capital gains X

Rental and Passive income X

Annuity “income” X

Tax-exempt bonds X

IRA/Qualified Plan distributions X

Principal residence X*

Vacation residence X

Life Insurance death benefits, loans and non-taxable distributions

X

* In excess of Exclusion amount ($250,000/$500,000)


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2013 Income Tax Bracket Summary


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Gifting and Estate Tax Basics

Gift, Estate and Generation Skipping**

Calendar Year Tax Exemption Tax Rate 2009 $3.5 million 45%

2010 $5 million 35% 2011 $5 million 35% 2012 $5.12 million 35% 2013 $5.25 million 40% Future years $5.25 million + Inflation Adjustment

Annual Gift Tax Exclusions (2013): $14,000***

Permanent change to 40% tax rate*, Exemption $5 million, indexed from 2010

*Top marginal rate** ATRA 2012 provides for indexing of Gift, Estate and GSTT exemptions*** indexed for inflation


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Clawback Issue now irrelevant At death, all gifts in excess of annual exclusions are added back to

decedent’s taxable estate Gifts made during 2011 or 2012 (utilizing $5 million+ exemption)

that are added back to estate, will never exceed estate tax exemption amount at time of death

Portability reduces need for Credit shelter or “by-pass” trust Property ownership between spouses no longer crucial Other considerations:

Estate tax return required to be filed at death of first spouse Unused exemption not indexed for cost of living Generation skipping exemption not portable Growth out of estate if credit shelter trust funded No basis step up for assets in credit shelter trust

Estate and Gift Tax Issues


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“Fiscal Cliff” is not over

Source: The Committee for a Responsible Federal Budget, available at: http://crfb.org/sites/default/files/Between_a_Mountain_of_Debt_and_a_Fiscal_Cliff.pdf

THE CONGRESSIONAL AGENDA…

Remaining “Fiscal Cliff” issues Sequestration –

postponed to March 1st Debt Ceiling

Technically reached Required increase in

March/April timeframe Federal Deficit issues


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The Fiscal Dilemma

As a share of GDP, spending and revenue collection historically average 19-20%

FY 2013 Projected Deficit: $1.2 trillion

National Debt: $16.4 trillion

Economic Growth Projections: 2.3% in 2012; ten-year average: 2.5%

Structural budget and tax reform likely in 2013???

Source: Office of Management and Budget, FY 2013 Mid-Session Review, available at: http://www.whitehouse.gov/omb/budget/MSR



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Remaining “Fiscal Cliff”

Debt Ceiling limit approaching - $16.4 trillion Tim Geitner told Congress Debt Ceiling was reached on December

26th. Government accounting steps taken to postpone day of reckoning until early March

Congress extended Government borrowing authority in a bill informally called “no budget, no pay” which raises the debt ceiling by $450 billion until May 18th, 2013 If there is no budget by April 15, 2013, Congress forgoes their

paychecks until a budget blueprint is passed

Mandated roughly $600 billion in across-the-board spending cuts take effect January 1 – Budget Control Act of 2011

Postponed to by ATRA 2012 to March 1, 2013 Over 1,000 government programs will receive deep, automatic cuts,

including Defense and Medicare


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Income Taxes in 112th / 113th Congress

Senate Finance Committee Chair Max Baucus

(D-MT) & House Ways & Means Committee

Chair Dave Camp (R-MI)


TAX REFORM…What we know

“Tax expenditures” serve as most significant source of revenue available for reform ($1.1T annually)Life insurance policy inside build-up and death benefits – 12th largest tax expenditure ($150 billion over five years)


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Select Tax Expenditures – “Cost” in Billions 2011-2015* Mortgage interest deduction $464.1 billion Real Estate Taxes $117.1 Charitable contributions $242.6 State and local, sales, and personal property taxes $230.3 Exclusion of gain on sale of residence $123.2 Carry over basis on gifts $ 26.6 Step-up in basis at death $230.8 Reduced rates capital gains/dividends $456.6 Exclusion of Cafeteria benefits (IRC 125) $197.6 Employer medical benefits $725.0 Pension contributions and earnings $804.8 Municipal bond interest $177.6 Not taxing inside build-up life insurance/annuities $148.3

*Joint Committee on Taxation Estimates of Federal Tax Expenditures 2011-2015 (1/17/12) Before passage of American Taxpayer Relief Act of 2012


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What to Do?

Planning Opportunities


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2013 Planning Opportunities

Income Tax Planning Closely monitor level of income - rate brackets, surtaxes, deduction phase-

outs Deferred compensation planning – no impact on application of .90%

Medicare surtax Client investment changes to reduce impact of 3.8% surtax Consider whether to convert from flow-thru entity to C Corporation

Especially if follow-thru on campaign promises to reduce corporate income taxes

Lower corporate tax rate to 28% Lower corporate rate on manufacturing to 25%

For short-term cash flow needs, consider low interest corporate loans rather than payment of compensation


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2013 Planning Opportunities Estate Planning

Gifting/Dynasty Trust planning remains vibrant for very wealthy Leverage gifts with discounts Leverage with low interest rate planning Don’t forget about State Estate taxes and planning

No Portability for state law purposes Use it or lose it – Some key planning techniques may be at risk

Life Insurance Greater opportunities to hold personally rather than need to transfer to irrevocable trust Life insurance in Qualified Plans* may become more popular

Less concern that death benefit is includable in estate Pay premiums with pre-tax dollars

In situations where premium is in excess of annual exclusions, consider a part-gift, part-loan arrangement

*Due to the complexity involved in this process, individuals are advised to consult with their tax adviser about the tax consequences associated with the purchase of life insurance in a qualified plan and to determine the proper methodology to use in executing such a plan.


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Planning for 3.8% Medicare Tax

Tax on investment income – dividends, interest, capital gains, distributions from annuities, rental income, passive business income

Does not apply to retirement plan distributions (including IRAs) although this income does impact MAGI and potential application of tax

Does not apply to interest from municipal bonds Does not apply to life insurance loans and non-taxable distributions Applies to trusts Early planning strategies:

Did I mention Life Insurance? Non-taxable investments may become more popular than ever Although -Tax expenditure item possibly in play to help pay for tax cuts Dividend paying stocks less popular? Tax efficient investments (low turnover and low dividends) Tax deferred investments (annuities) Nondeductible IRAs – the wallflower no more


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Low Interest Rate Planning Opportunities


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Gifting Still Beneficial: Gifts to Trust Rather than Outright

Why gifts into trust? Trust assets can continue to be available for grantor’s family

through a spouse or children named as eligible beneficiaries Protection from creditors and predators Grantor can borrow from trust, paying reasonable interest rate Grantor can retain right to substitute assets of equal value Grantor’s spouse can be given testamentary power of

appointment to change distribution terms of trust at her death Trust can appoint a “trust protector” with power to change trust

terms in event of change in family circumstances or tax laws Trust assets remain outside of taxable estate of beneficiaries Grantor can retain power to remove and replace trustee


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Gifts into Trust (cont.)

Grantor trust rules can further enhance flexibility and ability of trust to appreciate in value

Grantor is taxed on all trust assets as if still owned by grantor Transactions between trust and grantor are not recognized for

income tax purposes No gain recognized on transactions between grantor and trust No interest required to be reported on loan transactions

Grantor’s payment of taxes on trust income is not considered a gift to trust

Trust is permitted to grow tax free, while grantor’s assets (which are subject to creditors and estate taxes) are

depleted


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Part Gift / Part Split Dollar Loan

Life insurance premiums may exceed gifting capability, but rather than doing a Split Dollar arrangement, grantor decides to lend shortfall to irrevocable trust

Example, Gil, age 50 desires to purchase a MassMutual Whole Life Legacy 65 policy (Select Preferred Non-Tobacco) with $200,000 annual premium in ILIT Available annual exclusions total $78,000 Gil will loan remaining premium to trust

Premium loan will have same loan options that we’ve already discussed: Demand loan with annualized short term rate used to measure

required interest Term loans using mid-term rate or long term rate

Remember that each new premium is a new term loan


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Part Gift / Part Split Dollar Loan – Assume 15 yrs policy premiums of $200,000

Let’s take a look at our example assuming 2.66% (March ‘13 long term) interest rate over life of loan (over long term a higher rate may be required)

Annual Cumulative Year Outlay Gift Loan Interest* Loan Y/E

1 200,000 82,000 118,000 3,139 121,139 2 200,000 82,000 118,000 6,361 245,500 3 200,000 82,000 118,000 9,669 373,169 4 200,000 82,000 118,000 13,065 504,234 5 200,000 82,000 118,000 16,551 638,786

10 200,000 82,000 118,000 35,424 1,367,171 11 200,000 82,000 118,000 39,506 1,524,67712 200,000 82,000 118,000 43,695 1,686,372 15 200,000 82,000 118,000 56,945 2,197,725 16 82,000 56,278 2,172,003 17 82,000 55,594 2,145,597 20 82,000 53,430 2,062,090 25 82,000 49,423 1,907,430

*Loan interest Accrued


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Part Gift / Part Split Dollar Loan – Assume 15 yrs policy premiums

Age 50, Select Preferred, Non-Tobacco, Whole Life Legacy 65 Initial Death Benefit $5,344,828, Premium of $200,000

Cumulative Non-Guaranteed Non-Guaranteed

Year Loan Y/E Policy CV* Death Benefit*

1 121,139 12,186 5,378,559

2 245,500 163,620 5,414,488

3 373,169 358,667 5,455,216

4 504,234 562,429 5,501,042

5 638,786 775,568 5,553,446

10 1,367,171 2,067,266 6,051,907

11 1,524,677 2,336,980 6,198,567

12 1,686,372 2,693,875 6,364,245

15 2,197,725 3,808,802 6,983,375

16 2,172,003 4,041,276 7,223,401

17 2,145,597 4,286,189 7,472,435

20 2,062,090 5,098,327 8,265,503

25 1,907,430 6,748,130 9,783,018

*These values are not guaranteed. They include dividends that are neither estimates nor guaranteed, but are based on the 2013 dividend scale. Dividends in future years may be higher or lower depending on the company’s experience.


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Part Gift / Part Split Dollar Loan – Case Study cont. Benefits of Arrangement:

Funding of life policy premiums with no current gift tax impact Payments on outstanding loan can be used to supplement Grantor’s retirement

income Other Considerations:

Calculations on prior slide assume a demand or term loan arrangement using the March 2013 long term rate of 2.66% 2012 Annualized demand loan rate was .22% (March 2013 - .22%) Parties can convert demand loan to term loan at any time to lock in a low

interest rate for a period of time Higher future interest rates may require an increase in amount of interest

charged Future annual exclusion increases will help to offset some interest increases

Outstanding loan balance will be includable in Grantor’s taxable estate


36For Producer And Professional Advisor Use Only. Not For Use With The Public.

Typically estate planning trusts are designed to terminate upon last to die of grantor and spouse. At that time trust would be distributed to children of grantor. If a child had predeceased, trust may continue until deceased child’s heirs attained a certain age or maturity.

A Generation Skipping Trust is designed to continue to hold trust assets beyond the children’s generation for the benefit of grandchildren, great grandchildren or longer. A “Dynasty Trust” is designed to continue indefinitely, or at least as last as long as state law allows.

Generation Skipping Opportunities in Trust


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Assets in trust are not includable in taxable estate of beneficiaries Creditor protection

Trust assets not subject to creditors of trust beneficiaries Helps to ensure that inheritance your clients provide to their

descendants does not end up in the hands of ex-spouses Flexibility in distributions

Trust can be structured as a “Family Bank” Protection and Preservation of family wealth Retention of control over asset disposition

Generation Skipping Opportunities in Trust - Benefits


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Leverage GSTT Exemption GSTT Exemption allocated against gifts to pay premiums,

significantly increasing ultimate exempt transfer Death benefit substantially increases value of trust at death

of grantor or grantors, providing trust beneficiaries with enhanced Gift and Generation Skipping tax leverage

Policy cash values*, and other trust assets, can be used to benefit trust beneficiaries prior to death of grantor/Insured

Generation Skipping Trusts – Why Life Insurance?

*Distributions under the policy (including cash dividends and partial/full surrenders) are not subject to taxation up to the amount paid into the policy (cost basis). If the policy is a Modified Endowment Contract, policy loans and/or distributions are taxable to the extent of gain and are subject to a 10% tax penalty.Access to cash values through borrowing or partial surrenders will reduce the policy’s cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.


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Leveraging Gifts

Minority interests in closely-held businesses will generally be discounted for lack of control, lack of marketability, lack of diversity, etc.

Limited partnership interests (holding real estate, securities, etc.) are generally discounted as a result of prohibition on owner’s participation in management activities

Life insurance can be an excellent way to leverage gifts for kids, grandkids and future generations


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Low Interest Rate Planning - Gift Loans

Loans to Trust or Kids to purchase assets from Donor/Lender Loans to purchase life insurance Arbitrage loans – Earnings can help pay life premiums

Example: Grantor lends $20 million to irrevocable trust Trust pays interest of $218,000 annually for 9 years at 1.09% (March) If trust earns 5% on its investments, that’s $1 million, resulting in net

annual cash flow to trust of $782,000 Over 9 years, over $7 million of gift tax free cash flows into trust Grantor pays any income taxes on trust’s investment earnings under

grantor trust rules At end of loan term, loan could automatically renew for anther 9 year

period, but at current interest rate Term could be longer (20, 30, 40 years) at Long Term Rate (2.66%)

Important: Trust should contain “seed money” equal to 10% of amount loaned to trust – this can be gifted prior to loan transaction


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Low Interest Rate Planning Installment Sale of Discounted Assets to Grantor ILIT

Installment Sale of Discounted Entity Assets to Grantor Trust (Intentionally Defective Irrevocable Trust-”IDIT”)

Step 1: Trust should be “seeded” with gift of at least 10% of value of assets involved in installment sale

IRS will disregard sale arrangement if trust looks solely to assets sold as the source to repay note and interest

Step 2: Grantor sells business interests to trust Sale price of minority interest eligible to be discounted Sale in exchange for promissory note for term of years Requires interest of at least AFR (Sec. 7872 rate)

Results: Under Grantor trust rules, no reportable gain on sale and no taxation on

trust interest payments Income generated on assets in trust taxable to Grantor Sale of Discounted Assets at Low Interest Rate may work as an effective

Estate Freeze technique


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Act Now Before it Goes Away

Window of opportunity may be closing for many of these planning options:Congress is looking at many different options to raise revenues in order to

cut federal deficits and to spare some of scheduled sunset changes Included among options being considered by Congress:

Eliminating ability to create an irrevocable “grantor trust” that is not includable in grantor’s taxable estate

Creating a 90 year rule against perpetuities for generation skipping trusts – meaning that after 90 years, a generation skipping tax will be imposed on the assets in a generation skipping trust

Eliminating discounts on transfers of non-business property Requiring a minimum 10% taxable gift on transfers into a GRAT Requiring that GRATs must last for a minimum of 10 years Restricting Crummey withdrawal rights as creating annual exclusion gifts


Illustration

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©2013 Massachusetts Mutual Life Insurance Company, Springfield, MA. All rights reserved. www.massmutual.com. MassMutual Financial Group is a marketing name for Massachusetts Mutual Life Insurance Company (MassMutual) and its affiliated companies and sales representatives

®

Whole Life Legacy 65 (WL-2007 and WL-NC-2007) is a level-premium, participating, permanent life insurance policy issued by Massachusetts Mutual Life Insurance Company, Springfield, MA 01111-0001

for producer and professional advisor use only. not for use with the public. the american taxpayer...

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