March, 2013
By Gary Pittsford, CFP®
President and CEO, Castle Wealth Advisors, LLC

In the first week of January our representatives in Washington finally passed some new tax legislation. Unfortunately, the results of these new tax laws will make it more difficult for all of us to do our income planning for this year and into the future.

I thought it would be a good idea to outline a few ideas on how this new tax legislation will affect us starting January 1, 2013. Keep in mind, not every piece of the new tax laws has been defined by the IRS yet. There is also a chance that there will be more changes to the tax code made this spring as the legislators in Washington continue to talk about increasing the debt ceiling.

To help put this in perspective, I have divided the new tax laws into different income categories to make them more understandable.

Income Tax Overview

First, if your income is less than $250,000 per year as a married couple ($200,000 for singles) your income taxes, credits, and deductions will be about the same as they were last year

Second, if your income as a married couple is between $250,000 and $450,000 ($200,000 to $400,000 for singles) you will have the following new tax issues to talk to your accountant about.

  • Long term capital gains will still be taxed at a rate of 15% for you, but you could have an additional 3.8% Medicare surtax to pay on all “investment” income such as interest, dividends, royalties, passive rent, and long term capital gains.
  • In addition to the 1.45% Medicare tax that we have historically been paying on wages, you will now pay an additional .9% Medicare tax which brings your total Medicare tax to 2.35% of your Adjusted Gross Income.

Third, if your income as a married couple is above $450,000 per year ($400,000 for singles) you need to be aware of the following changes:

  • Your maximum income tax bracket last year was 35%. Starting this year, it will be 39.6%.
  • Long term capital gains will be taxed at 20%, plus you could be subject to the additional 3.8% Medicare surtax. In short, your capital gains tax last year was 15% and this year it could be as high as 23.8%.

Investment Decisions

Because income taxes will be higher for most of our clients, it may become necessary for us to discuss new investment strategies that could generate more spendable income to help maintain the same level of cash flow. Because your total income taxes may be higher, tax free municipal bonds look even better this year than they did in the past. As interest rates start to increase in one or two years, we will have to work hard to protect municipal bond values.

High dividend paying equities are still an important part of a well allocated portfolio. Starting this year, we will need to monitor our client’s total tax on dividends to see if a different type of asset would be better for some more than others.

Floating rate bonds is an asset category that is becoming more important to clients not only for interest income but also for additional protection against rising interest rates for their portfolios. Diversification of assets is more important now than ever before based upon low interest rates, the stock market rising, and the worldwide economic fragility.

Starting this year, it will be important to monitor our clients’ different types of income. That information will help us in designing asset allocations that have the potential to minimize taxes and provide good cash flow.

Income Management

As always, our Castle Wealth Advisors® team will continue to work together to monitor our clients’ income sources and provide ideas that fit their tax bracket and the economy for 2013.

  • It might be beneficial to reduce taxable interest and dividends and increase tax free municipal bond income.
  • Clients whose income is between $250,000 and the $450,000 threshold may be advised to move income into future years if possible.
  • If a corporate executive has income this year of $400,000 with the possibility of an additional $200,000 bonus, we may want to find ways to postpone the bonus into a lower tax rate next year.
  • If a business owner is selling a building or some closely held stock for perhaps $600,000, it may be better to have the sales recognized over three years rather than one year.

Because of the different income tax brackets, different taxes on investment income, and the fact that legislation is still changing, we will spend more time reviewing the makeup of our client’s income to see if any changes can be made which would be beneficial.

Gift and Estate Tax

We were surprised and glad to see that the lifetime gift exemption remained at $5 million rather than it being reduced back to $1 million. Now that the exemption is tied to a CPI inflation factor, the new lifetime exemption for 2013 is $5,250,000.

A number of our clients gave away $5 million of assets last year in order to use up their higher lifetime exemption. Every family has different goals and a different net worth. Because of that, we will continue to work on gifting strategies for clients in this new year.

With the estate tax exemption staying at the new higher limit of $5,250,000 per spouse, we have already started helping our clients to update their estate planning documents to protect more assets for future generations.

One very positive change in the estate tax laws was the incorporation of “Portability” with the federal estate tax exemption. This means that if one spouse’s estate does not use up all of their $5,250,000 exemption, the remaining exemption can be used by the surviving spouse. For example, if a husband dies with a taxable estate of $3 million, his remaining $2,250,000 can be carried over to his spouse. She would then have her own $5,250,000 exemption plus the carry over of $2,250,000 which would shelter a total of $7.5 million when the second spouse passes away. The portability of the estate tax exemption will be very helpful when we are creating long term estate strategies for families over the coming years.

One issue we are paying very close attention to is the taxation of income from different types of Irrevocable Trusts. Irrevocable Trusts may have to pay higher income taxes starting in 2013. In a case where a family has established a trust that is no longer part of the donor’s estate, the amount and type of income from that trust can have significant income tax consequences to beneficiaries.

For instance, if a spouse dies and assets are divided into two or three different Trusts, we want to make sure that the trustee is not only electing to pay out interest and dividends, but also distributing long term capital gains if and when appropriate. Trusts have very compressed income tax brackets and will reach the maximum rate of 39.6% with as little as $11,950 of income. An individual taxpayer does not reach that tax bracket until he or she has $400,000 of income. To mitigate the higher taxes the Trust would be subjected to, we want to make sure that the Trust document provides the flexibility to allow the trustee to pay out most, if not all of the income earned in the trust. Remember, long term capital gains will be taxed at the 20% tax rate, plus they will also start paying the 3.8% Medicare surtax. A trust is subject to the additional 3.8% if the income in the trust is at or over $11,950.

Other Tax Planning Opportunities

Taxpayer’s 70½ years old are still permitted to contribute $100,000 from their IRA directly to charity through the end of 2013. This is a great way to benefit a charity, improve the deductibility of your contribution and keep your Adjusted Gross Income from rising.

Now that many of our clients are subject to higher tax rates, we want to make sure that they are taking advantage of write-offs, deductions, and reductions to their taxable income as much as possible. For instance, the new tax laws still provide for the depreciation of equipment and for bonus depreciation.

Congress and the IRS have debated for several years about limiting the use of Family Limited Partnerships. Under the new tax regime, these types of entities can still be used effectively for families, especially for those that have closely held family businesses.

The discounting of value on minority stock in a family held business has also been included in the new tax law. While, there was some debate in the past about the elimination of this provision benefiting families that own closely held businesses, the discounts have been preserved.

Income tax laws have changed which will affect the amount and type of income that you have coming in this year. Estate tax and gift tax exemptions have now been finalized. Because of that, we can start making necessary changes to Wills and Trusts and begin discussing different ways to help protect your net worth and preserve assets for your family or charities.

Gary Pittsford, CFP® is President and CEO of Castle Wealth Advisors, LLC. Castle specializes in helping high net worth families and closely-held business owners with asset management strategies, succession planning, estate and income tax analysis and family gifting techniques. Castle’s senior partners work with clients throughout the country in making logical decisions that help them fulfill their personal and business financial goals. For more information visit, call 1-888-849-9559 or e-mail Gary directly at .