2015 Year-End Tax Planning Summary

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Despite a great deal of commentary about the inequities and inefficiencies of the current income tax code, 2015 did not see the enactment of significant tax legislation. In fact, Congress has yet to act on a series of tax extenders (the 50-plus provisions that expired at the end of 2014 that are temporarily extended year after year). Even though there have been few changes, all taxpayers are still encouraged to consider their current tax situation and decide whether it makes sense to take steps to minimize their 2015 tax liability prior to year-end.

For 2015, individual taxes are assessed at the following rates:

   In addition to the taxes summarized in the above schedule, the Affordable Care Act created additional taxes that became effective in 2013 and are scheduled to continue indefinitely. The most prominent of these taxes are:

Increased Medicare Tax – An individual is liable for an additional Medicare Tax equal to 0.9% if the individual’s wages, other compensation, or self-employment income (together with those of his or her spouse if filing a joint return) exceed the threshold amount for the individual’s filing status. Thus, the wage withholding rate for Medicare taxes is 1.45% up to the income threshold and 2.35% (1.45% + 0.9%) on amounts in excess of the threshold amounts. The threshold amount for purposes of the increased Medicare tax is $250,000 for married couples filing a joint return, $125,000 for married individuals filing a separate return and $200,000 for single taxpayers.

Net Investment Income Tax – A surtax of 3.8% is imposed on the unearned income of individuals, estates, and trusts above a threshold amount of $250,000 for married couples filing a joint return, $125,000 for married individuals filing a separate return and $200,000 for single taxpayers. For individuals, the surtax is 3.8% of the lesser of:

The taxpayer’s net investment income; or

The excess of modified adjusted gross income over the threshold amount.

Investment income includes income from interest, dividends, annuities, royalties, rents (not derived from a trade or business), capital gains (not derived from a trade or business), trade or business income that is a passive activity with respect to the taxpayer, and trade or business income with respect to the trading of financial instruments or commodities. The surtax on unearned income results in long-term capital gains and qualified dividends being taxed at rates as high as 23.8% (20% + 3.8% surtax).

The increased tax rate on long-term capital gains for high income taxpayers along with the additional 3.8% surtax on net investment income makes it all the more important that individuals monitor their capital gains and losses. If you have recognized gains during the year, you may wish to consider selling investments that have losses to offset those gains.

Congress has failed to act on various tax extenders

As has been true each of the past several years, Washington has failed to address various tax extenders that expired at the end of last year. Extenders are tax items (credits or deductions) that have an expiration date. Without an extension, these tax provisions essentially disappear. There are approximately 50 such items that expired over the past year that need to be addressed. These items range from the tax deduction for sales taxes paid to research tax credits. The delay in addressing these extenders may cause a delay in the Internal Revenue Service issuing 2015 tax forms and a similar delay in processing returns.

We often receive questions about the tax-free distribution of funds from an individual retirement account for charitable purposes. Unfortunately, this provision has not yet been extended for 2015. Under the provision that was in effect the past several years, individuals age 70½ or older had been permitted to make direct transfers of up to $100,000 annually from an individual retirement account to a charitable organization. By distributing funds directly from your IRA to charity, the distribution is not included in the account owner’s taxable income (and the account owner is not allowed to claim a tax deduction for the charitable contribution). Without this provision, if an individual wished to contribute IRA assets to charity, the individual would be required to take a distribution from his IRA and then contribute the funds to charity. The individual would include the distribution in income, but would be allowed a charitable deduction for his contribution. Unfortunately, the deduction in many cases would not fully offset the additional income because of (among other things) the phase-out of itemized deductions for high-income taxpayers. Likewise, most states, including Illinois, do not allow a charitable deduction. As a result, including the IRA distribution into income before claiming the charitable deduction may also increase state taxes.

Maximize contributions to tax-deferred retirement accounts

Maximizing contributions to tax-deferred retirement accounts, such as an Individual Retirement Account or a company 401(k) plan, will reduce your taxable income and your tax liability. The 401(k) contribution limit for 2015 is $18,000. In addition, individuals who will be at least 50 years of age by the end of 2015 may make an additional “catch-up” contribution of $6,000. The contribution limit will remain unchanged for 2016 and will be $18,000. The catch-up contribution limit for 2016 will also remain at $6,000.

Contributions to Individual Retirement Accounts may also be tax deductible (depending upon your income and whether you participate in an employer sponsored retirement plan). For 2015, the contribution limit is $5,500. In addition, individuals who will be at least 50 years of age by the end of 2015 may make an additional “catch-up” contribution of $1,000 in 2015. The contribution limits for 2016 will not change.

Self-employed individuals may consider establishing a simplified employee pension (SEP) plan. By utilizing a SEP, self-employed individuals may be able to contribute up to $53,000 to a tax-deferred retirement account. Further, contributions for 2015 need not be funded until the extended due date for filing the individual’s 2015 tax return.

Estate & Gift Taxes

For 2015, the estate and gift exemption amount is $5.43 million ($10.86 million for married couples). The exemption amount is indexed for inflation and will increase in 2016 to $5.45 million ($10.9 million for married couples). The top tax rate for estate and gift tax purposes has also been set at 40%.

The generation-skipping transfer (“GST”) tax is still in place. Generally, the tax applies to lifetime and death-time transfers to or for the benefit of grandchildren or more remote descendants. For 2015, the rate is a flat 40%. The tax is in addition to any gift or estate tax otherwise payable. As with the gift and estate tax, each taxpayer is allowed a $5.43 million GST tax exemption for 2015.

Consider Lifetime Gifts that take Advantage of both the Gift Tax Exemption and GST Exemption

Many clients utilize a portion or all of their $5.43 million gift tax exemption ($10.86 million for a married couple) by structuring long-term GST exempt trusts benefiting multiple generations. Such trusts will remain exempt from all gift and estate tax as long as the trust remains in existence. Under Illinois law, such trusts can last in perpetuity, thereby allowing you to create a family “endowment fund” for your children, grandchildren and future descendants.

If you already have taken advantage of the current $5.43 million exemption amount or you are not in a position where it makes sense to gift a large amount, you should still continue to plan a gifting strategy going forward.

Annual Exclusion Gifts

In 2015, you may make a gift of $14,000 to any individual and certain trusts without any gift tax consequences. Married individuals may make gifts of up to $28,000. Gifts may be made outright or in trust and may be in the form of cash, securities, real estate, artwork, jewelry or other property. Giving property that you expect to appreciate in the future is an excellent way of utilizing your annual exclusion gifts because any post-gift appreciation is no longer subject to gift or estate tax. To take advantage of your annual exclusions for 2015, gifts must be made by December 31. Gifts over $14,000 or gifts that will be “split” between spouses must be reported on a gift tax return, which must be filed in April 2016. The annual exclusion amount is scheduled to remain $14,000 in 2016, $28,000 for married couples.

Payment of Tuition and Medical Expenses

In addition to annual exclusion gifts, you may pay tuition and medical expenses for the benefit of another person without incurring any gift or generation-skipping transfer (“GST”) tax or using any of your estate or GST tax exemption. These payments must be made directly to the educational institution or medical facility. There is no dollar limit for these types of payments and you are not required to file a gift tax return to report the payments.

Take Advantage of Today’s Low Interest Rates

Interest rates remain at historically low levels. Low interest rates enhance the benefits of several gift and estate planning strategies. One such strategy is the “grantor retained annuity trust” or GRAT. A GRAT is an irrevocable trust to which a donor transfers property and retains the right to receive a fixed annuity for a specified term. At the expiration of the term, the property usually passes outright or in trust for the benefit of descendants or other named beneficiaries. The amount of the gift resulting from the transfer of the property to the GRAT is the present value of the remainder interest that passes to the beneficiaries at the end of the term. Under the valuation methods adopted by the IRS, the lower the interest rate at the time of the gift, the lower the present value of the remainder interest and the smaller the amount of the gift that must be reported to the IRS. Interests in closely held family businesses or marketable securities with high growth prospects are often ideal properties to transfer to a GRAT. While there has been considerable discussion about disallowing “zeroed-out” GRAT’s and requiring a minimum GRAT term of 10 years, Congress has not taken any action in this respect. As a result, GRAT’s remain a very attractive planning opportunity.

Example – Individual funds a GRAT with $1 million. The GRAT’s term is 5 years and its assets appreciate at a rate of 8%. Assuming the applicable IRS interest rate is 2.0% (the rate in effect for December 2015) and the GRAT is “zeroed-out,” the remainder value of the GRAT assets at its termination would be approximately $250,000.

In other words, the GRAT structure would have allowed the individual to transfer assets valued at approximately $250,000 to his children or designated beneficiaries without incurring any gift tax obligation or utilizing any of his or her lifetime exemption amount.

Low interest rates also make sales to “defective” grantor trusts more attractive. Under this strategy, a taxpayer creates a trust, typically for his or her spouse and descendants. The taxpayer then sells assets to the trust taking back a note requiring the trust to repay the taxpayer in installments. The trust is structured so that it is ignored for income tax purposes, resulting in no income tax consequences upon the sale. The interest paid on the note is typically at the applicable federal rate, which changes month to month based on current market rates. The lower the interest rate on the note, the greater the amount of assets that will accumulate in the trust free of estate, gift and GST taxes.

For more information, please contact Greg Winters at 312/840-7059 or gwinters@burkelaw.com.

330 North Wabash Avenue, Suite 2100
Chicago, Illinois 60611-3607
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