2016 Year-End Estate and Tax Planning Summary

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Professionals

Few people predicted that Donald Trump would win the presidency and fewer still predicted that the Republican Party would control both houses of Congress along with the White House. While 2016 did not see the enactment of a great deal of tax legislation, 2017 and 2018 could see significant changes to the tax code the likes of which we have not been seen since 1986.

With the end of the year fast approaching and the prospects of significant changes to the tax code on the horizon, taxpayers should consider taking steps to not only minimize their 2016 tax liability, but also position themselves for possible changes to the tax code in 2017. 

Potential Changes to Individual Income Taxes

The primary thrust of Trump’s proposed tax plan is simplification. The first and most notable change would be the reduction in the number of tax brackets from 7 to 3.

Current Individual Income Tax Rates

Taxable Income

Joint/(Single)

Tax Rate

Long-Term Capital

Gains Rate

Qualified Dividend Rate

$0 - $18,550

($0 - $9,275)

10%

0%

0%

$18,551 - $75,300

($9,276 - $37,650)

15%

0%

0%

$75,301 - $151,900

($37,651 - $91,150)

25%

15%

15%

$151,901 - $231,450

($91,151 - $190,150)

28%

15%

15%

$231,451 - $413,500

($190,151 - $413,500)

33%*

15%**

15%**

$413,501 - $466,950

($413,501 - $415,050)

35%*

15%**

15%**

Over $466,950

(over $415,050)

39.6%*

20%**

20%**

*          Pursuant to the Affordable Care Act, married couples filing a joint return pay an additional 0.9% Medicare tax on any wages, other compensation, or self-employment income over $250,000. For individuals, the additional Medicare tax applies to wages, other compensation, or self-employment income over $200,000.

**        Pursuant to the Affordable Care Act, married couples filing a joint return are subject to a 3.8% surtax on net investment income (interest, dividends and capital gains) if their income exceeds $250,000. For individuals, the surtax applies if an individual’s income exceeds $200,000.

Trump’s Tax Plan – Individual Income Tax Rates

Taxable Income

Joint/(Single)

Tax Rate

Long-Term Capital

Gains Rate

Qualified Dividend Rate

$0 - $75,000

($0 - $37,501)

12%

0%

0%

$75,001 - $225,000

($37,500 - $112,500)

25%*

15%*

15%*

Over $225,000

(over $112,500)

33%*

20%*

20%*

*          The Trump plan would eliminate the additional 0.9% Medicare tax on high income earners and the 3.8% tax on net investment income created under the Affordable Care Act.

In addition to reducing the number of tax brackets, the Trump plan proposes the following changes to the individual income tax laws:

Consider taking steps to accelerate deductions

Each year, we discuss the possibility of accelerating certain itemized deductions. For example, individuals making state estimated tax payments can make their 4th quarter payment prior to year-end. In doing so, they are allowed a deduction for state income taxes paid on their 2016 federal income tax return. 

Given the fact that the Trump plan proposes to limit itemized deductions to $200,000 for married couples filing a joint return (or $100,000 for single filers), it is all the more important that high income taxpayers consider accelerating deductions prior to year-end. In addition to making state estimated tax payments early, individuals may also consider accelerating charitable contributions. 

It should be noted that while the GOP blueprint for reforming the tax code does not provide a hard cap to itemized deductions like the Trump plan, the GOP blueprint would eliminate all itemized deductions with the exception of the deductions for charitable contributions and the deduction for home mortgage interest expense. While no one is certain what changes will be made to the tax code relative to deductions, both the Trump plan and the GOP blueprint would severely limit individual itemized deductions.

Defer the receipt of taxable income

Each year we recommend considering steps to defer receipt of taxable income. Just as we noted with respect to accelerating itemized deductions, this consideration is all the more important this year as both President-Elect Trump and the GOP blueprint have proposed a reduction in the top federal tax rates. Both the Trump Plan and the GOP blueprint call for a top federal tax rate of 33%. This compares to the current top federal tax rate of 39.6%.

While possible changes to the tax code in 2017 and beyond impact many considerations relative 2016 income and deductions, there are still several planning options that are unaffected. For example, individuals may still consider the following:

IRA Charitable Rollover

In 2016, Congress and President Obama made permanent the provision allowing individuals age 70½ and older the ability to distribute up to $100,000 annually from an IRA 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). 

Estate & Gift Taxes

Both President-Elect Trump and the GOP blueprint call for significant changes to the current estate and gift tax laws. Specifically, both have called for the elimination of the estate and gift tax. 

President-Elect Trump ran a populist campaign and it is doubtful that an elimination of the estate and gift tax would be well received by a large percentage of his supporters. While it is possible that steps may be taken to eliminate or further curb the estate and gift tax, we feel that it is more likely that the administration will focus their initial legislative efforts on other items in their platform (i.e., immigration, healthcare, income taxes and infrastructure spending). As such, we do not anticipate any immediate changes to the estate and gift tax. In turn, we are recommending that individuals continue planning for the estate and gift tax until such time as concrete steps have been taken by the administration and Congress to eliminate the tax.

For 2016, the estate and gift exemption amount is $5.45 million ($10.90 million for married couples). The exemption amount is indexed for inflation and will increase in 2017 to $5.49 million ($10.98 million for married couples). The top tax rate for estate and gift tax purposes has 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 2016, the rate is a flat 40 percent. 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 $5.45 million GST tax exemption for 2016. 

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

Many clients utilize a portion or all of their $5.45 million gift tax exemption ($10.9 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 $5.45 million exemption amount or you are not in a position where it makes sense to gift a large amount, you should still continue a gifting strategy going forward. 

Annual Exclusion Gifts

In 2016, 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 will 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 2016, 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 2017. The annual exclusion amount will remain at $14,000 in 2017, $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 6%. Assuming the applicable IRS interest rate is 1.6% (the rate in effect for November 2016) and the GRAT is “zeroed-out”, the remainder value of the GRAT assets at its termination would be approximately $120,000. In other words, the GRAT structure would have allowed the individual to transfer assets valued at approximately $120,000 to his children or designated beneficiaries without incurring any gift tax obligation or utilizing any of his or her lifetime exemption amount. If the assets inside the GRAT were to appreciate at a rate of 8%, the remainder that would be available to the trust’s beneficiaries would be approximately $210,000.

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 in effect at the time of the sale. 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.

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