1. The American Taxpayer Relief Act of 2012, PPACA and General Tax Update
September 19, 2013
© 2013 Elliott Davis, PLLC © 2013 Elliott Davis, LLC

2. This material was used by Elliott Davis during an oral presentation; it is not a complete record of the discussion. This presentation is for informational purposes and does not contain or convey specific advice. It should not be used or relied upon in regard to any particular situation or circumstances without first consulting the appropriate advisor. No part of the presentation may be circulated, quoted, or reproduced for distribution without prior written approval from Elliott Davis.
© 2013 Elliott Davis, PLLC © 2013 Elliott Davis, LLC

3. The American Taxpayer Relief Act of 2012
Who does it affect?
Individuals
Estates
Businesses

4. The American Taxpayer Relief Act of 2012 - Individuals
Tax Brackets
The 10%, 15%, 25%, 28% & 33% tax brackets have been permanently extended
The 39.6% bracket has been added for single individuals with taxable income over $400,000($450,000 MFJ)

5. The American Taxpayer Relief Act of 2012 - Individuals
Personal Exemption Phase-out
Starting in 2013, personal exemptions are phased-out for single taxpayers with AGI above $250,000 ($300K MFJ)
Itemized Deductions Limitation
Starting in 2013, itemized deductions are limited for single taxpayers with AGI above $250,000 ($300K MFJ)

6. The American Taxpayer Relief Act of 2012 - Individuals
Capital Gains & Dividend Rates
The bill permanently extends the current capital gains and dividend tax rates for individuals with income at or below $400,000 ($450,000 MFJ). For income above those thresholds, the rate for both capital gains and dividends will be 20%.
Under current law, the dividend and capital gain rates for taxpayers below the 25% bracket is 0%. For those in between the 25% tax bracket and those with taxable income under $400,000 ($450,000 MFJ), the capital gains and dividend rates are 15%.

7. The American Taxpayer Relief Act of 2012 - Individuals
Permanent AMT Patch
The AMT patch is now PERMANENT! The bill, which increases the exemption amounts for 2013 to $51,900 (individuals) and $80,800 (MFJ), indexes the exemption and phase-out amounts thereafter. In addition, the bill allows the nonrefundable personal credits against the AMT.
Mortgage Debt Relief
The Mortgage Debt Relief Act of 2007 was extended for one year through It allows taxpayers who have mortgage debt relief canceled or forgiven to have up to $2 million excluded from income.

8. The American Taxpayer Relief Act of 2012 - Individuals
Mortgage Insurance
The bill extends the ability to deduct mortgage insurance on a qualified personal residence for 2012 & 2013.
State & Local General Sales Tax Deductions
The bill extends the ability to elect to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction permitted for state and local income taxes.
Tax-Free Distributions from Individual Retirement Plans for Charity
The bill extends for two years the provision that permits tax-free distributions to charity from an IRA held by someone age 70.5 or older of up to $100,000 per taxpayer, per taxable year.

9. The American Taxpayer Relief Act of 2012 - Individuals
Education Extensions
The employer-provided educational assistance income exclusion was permanently extended. An employee may exclude from gross income up to $5,250 per year for undergraduate and graduate education.
The expanded student loan interest deduction (“above-the-line”) was permanently extended.
The American Opportunity Tax Credit was extended through It is available for up to $2,500 of the cost of tuition and related expenses.
The “above-the-line” deduction for qualified tuition related expenses was extended through 2013.

10. The American Taxpayer Relief Act of 2012 - Individuals
Marriage Penalty Relief
The bill permanently extends marriage penalty relief for the 15% bracket, the standard deduction and the EITC .
Dependent Care Credit
This credit was permanently extended. It allows a 35% credit of up to $6,000 of eligible expenses.
Child Tax Credit
This bill permanently extends the 2001 modifications to the child tax credit. Generally, taxpayers with income below certain threshold amounts may claim the child tax credit for each qualifying child under the age of 17.

11. PPACA
The Patient Protection and Affordable Care Act (“PPACA”), as amended by the Health Care and Education Reconciliation Act of 2010 (“2010 RA”), is designed to drive fundamental reforms to the United States health care system.
The new law includes over $400 billion in revenue raisers and new taxes on employers and individuals.

12. PPACA – All Individuals
Itemized Deduction for Medical Expenses
For tax years beginning after December 31, 2012, the threshold for medical expense deductions is raised to 10% of AGI (up from 7.5%)
Threshold remains at 7.5% until 2017 for those 65 or older
Limit on Health FSAs
For tax years after 2012, the maximum salary reductions under FSA plans will be limited to $2,500 per year
Will be indexed for inflation thereafter

13. PPACA – High Income Earners
0.9 % Medicare HI Tax – Earned income
3.8% Medicare HI Tax – Unearned income
A taxpayer should never pay both the 0.9% tax on earned income and the 3.8% tax on the same stream of income.

14. PPACA – High Income Earners
Beginning January 1, 2013, an additional .9% Medicare Hospital Insurance tax (HI) will be applied on earnings of self-employed individuals or wages in excess of $200,000 ($250,000 if individual or employee files a joint return).
Example: Beth is single and earns $500K. Her HI Tax will be $2,700 [($500,000 - $200,000) * 0.9%)].

15. PPACA – High Income Earners
Beginning January 1, 2013, an additional 3.8% Medicare Hospital Insurance tax (HI) will be applied to unearned income (Note: From now on, we will refer to this tax as the Net Investment Income Tax (NIIT)).
Tax will be applied on the lesser of the following:
“Net investment income,” OR
The excess (if any) of –
a. “Modified adjusted gross income (“MAGI”) over the
b. “Threshold amount”

16. Net Investment Income Tax (NIIT)
Consider the following when calculating the net investment income tax (NIIT):
Includes:
Does NOT Include:
Interest
Salary, wages, or bonuses
Dividends
Distributions from IRAs or qualified plans
Annuity Distributions
Any income taken into account for self-employment tax purposes
Rents
Gain on the sale of an active interest in a partnership or S corporation
Royalties
Items which are otherwise excluded or exempt from income under the income tax law, such as interest from tax-exempt bonds, capital gain excluded under IRC 121, and veterans benefits

17. Net Investment Income Tax (NIIT)
Modified Adjusted Gross Income
The amount that is compared to the “threshold amount” to determine the “net investment income” that is subject to the surtax
MAGI equals
Adjusted gross income (Form 1040, line 37)
Plus
Net foreign earned income exclusion
Plus/Minus
Certain items of foreign income from CFCs and QEFs

18. Net Investment Income Tax (NIIT)
“Threshold amounts” are defined as follows:
Single taxpayers - $200,000
MFJ taxpayers - $250,000
MFS taxpayers - $125,000
Estates/Trusts - $11,950

19. Net Investment Income Tax (NIIT)
For tax year 2013, Investor X (married filing jointly) has $275,000 of net unearned income (interest and dividends less any allowable deductions). Investor X also has $500,000 of W-2 income.
The NIIT is calculated as follows: 3.8% times the lesser of (a) $275,000 (net investment income) and (b) $775,000 (modified AGI) minus $250,000 (threshold amount). This results in a tax of $10,450 (3.8% of Investor X’s net investment income).

20. Net Investment Income Tax (NIIT)
For tax year 2013, Investor Y (married filing jointly) has $275,000 of net investment income and $125,000 of W-2 income.
The NIIT is calculated as follows: 3.8% times the lesser of (a) $275,000 (net investment income) and (b) $400,000 (modified AGI) minus $250,000 (threshold amount). This results in a tax of $5,700 (3.8% of the excess of Investor Y’s modified AGI less the threshold amount).

21. Net Investment Income Tax (NIIT)
For estates and trusts, the NIIT is calculated in a similar manner.  The NIIT is equal to 3.8% times the lesser of undistributed “net investment income” for such taxable year or the excess (if any) of “Adjusted Gross Income” for such taxable year, over the dollar amount at which the highest tax bracket begins for such a taxable year.  However, for estates and trusts the 3.8% threshold starts at only $11,950.

22. Net Investment Income Tax (NIIT)
John Smith – Deceased
Estate/Trust
$0 employment income
Undistributed $225,000 net investment income
MAGI                                $225,000
Threshold                      <$  11,950>
Excess                              $213,050 
The 3.8% NIIT would apply to $213,350 ($8,096 of net investment income tax)

23. Net Investment Income Tax (NIIT)
Ann Thomas Trust
$100,000 investment income
Has made distributions of 100% of income (i.e. no undistributed income for purposes of NIIT calculations)
The 3.8% NIIT would NOT apply
Note: Although the trust is not subject to the 3.8% NIIT, the income passed out to the beneficiary through a K-1 would potentially be subject to the 3.8% calculations at the individual level.

24. Planning Around the NIIT
Strategies for reducing net investment income:
Life Insurance
Municipal bonds
Rental real estate
Oil & gas investments
Timing of trust/estate distributions

25. Planning around the NIIT (Life Insurance)
Jack, a married-filing-jointly taxpayer, recently paid a $250,000 premium to purchase a $2,000,000 second-to-die whole life insurance policy. A few years passed and he withdrew $50,000 from the cash value when it was worth $450,000.
Under this scenario, none of the $200,000 earnings to date (or any future earnings) are subject to the 3.8% NIIT until Jack withdraws more than his initial single premium amount.

26. Planning Around the NIIT (Life Insurance)
In addition, even if Jack withdraws earnings from the life insurance policy in a future year, none of the earnings will be subject to the 3.8% NIIT provided that Jack’s MAGI (which would include the earnings withdrawn from the life insurance policy) is below the threshold amount, which is $250,000 for married-filing-jointly taxpayers.

27. Planning Around the NIIT (Municipal Bonds)
Municipal bond interest is exempt from both the federal income tax and the 3.8% NIIT. Non-NC municipal bond interest is taxable in NC, but consider that these bonds will be even more attractive in 2014 when the NC tax rate drops to 5.8% from 7.75%.
Example: Anna, a single taxpayer, inherited $1 million from her aunt and has determined that she would like to invest the money either in (a) corporate taxable bonds earning 7% or (b) tax-exempt municipal bonds earning 4.5%. Assuming that Anna is in the 39.6% marginal income tax bracket for the 2014 tax year and lives in NC, below is a summary of the after-tax yield of each investment:
Corporate Bond Municipal Bond
3.556% %
{7% * [1 – (39.6% + 3.8% + 5.8%)} {4.5% * [1 – 5.8%)}

28. Planning Around the NIIT (Rental Real Estate)
Net Income
$200,000
Less: Depreciation
(50,000)
Equals: Taxable Income
$150,000
Net Cash Flow
The $50,000 depreciation shelters both income tax and NIIT.

29. Planning Around the NIIT (Oil and Gas Investment)
Oil and gas investments can be categorized as either passive or material participation activities. During the drilling phase, oil and gas investments can produce losses in the early years.
If a taxpayer invests through a limited partnership, the losses would be passive and any income generated would be subject to the 3.8% tax.
On the other hand, direct investment in working interests are not passive, which means that there is no limit on passive losses in early years, but income would be subject to self-employment tax in later years.

30. Planning Around the NIIT (Oil and Gas Investment)
John, a single taxpayer, recently invested $100,000 in a working interest in an oil well through a limited partnership.
The oil well driller’s accountants indicate that 80% of the initial investment can be deducted in the first year as an “intangible drilling cost” (IDC).

31. Planning Around the NIIT (Oil and Gas Investment)
Assuming that John has $80,000 of net investment income subject to the NIIT and is in the 39.6% bracket, his tax savings would be as follows:
Income tax savings from IDC deduction $31,680
[($100,000 * 80%) * 39.6%]
NIIT savings from IDC deduction $3,040
[($100,000 * 80%) * 3.8%]
Total tax savings $34,720

32. Planning around the NIIT (Trust/Estate Distribution)
Timing of Distributions – A trust can decide to make distributions in years when the beneficiaries’ income is below the threshold or not make distributions when the trust income would be less than the threshold.  This would maximize the use of the thresholds.
65 Day Rule on Distributions (663(b) Election) – This election can be made by the fiduciary of a complex trust or the executor of a decedent’s estate and allows for distributions paid by the trust or estate within 65 days after the end of the prior taxable year to be counted as distributions for the prior taxable year, therefore allowing income to be passed out to the beneficiaries if so desired. 

33. Planning around the NIIT (Trust/Estate Distribution)
During 2013, the Jones Family Trust had $200,000 of net investment income and $49,900 of deductible expenses. The trustee is trying to decide if a distribution of trust accounting income should be made. Assuming the trust beneficiary is single and has gross income below the NIIT threshold amount, below is a summary of the tax savings that would occur if a $150,000 distribution was made: No
$150K
Distribution
Gross Income
$ ,000
$ ,000
Minus: Deductible Expenses
$ (49,900)
$ (49,900)
Adjusted Total Income
$ ,100
$ ,100
Minus: Income Distribution Deduction $
$ (150,000)
Minus: Exemption
$ (100)
$ (100)
Taxable Income
$ ,000 $
Income Tax at Trust Level
$ ,434
Income Tax at Beneficiary Level $
$ ,731
Total Income Tax
NIIT at Trust Level
$ ,234
NIIT at Beneficiary Level $
Total Medicare Surtax
Total Taxes
$ ,668
Savings
$ ,937

34. Minimizing MAGI Installment sale Roth IRAs Charitable remainder trusts
Charitable IRA rollover provision
Above-the-line deductions

35. Minimizing MAGI (Installment Sale)
Installment sale: When a seller sells an asset to a buyer in exchange for a promissory note paid over a period of time.
The taxable gain recognized by the seller can be deferred until principal payments are made.
The goal would be to spread net investment income over a longer period of time in order to keep MAGI below the threshold amount.

36. Minimizing MAGI (Roth IRAs)
Roth IRA Benefits
Decreases taxable income long-term
Tax-free compounding
No RMDs at age 70.5
Tax free withdrawals for beneficiaries
Purpose as it relates to the NIIT:
To lower MAGI below the threshold amount over the long-term

37. Minimizing MAGI (Charitable Remainder Trusts)
A charitable remainder trust (CRT) is a split interest trust consisting of an income interest and a remainder interest.
During the trust’s term, the income interest is usually paid out to the beneficiary.
At the end of the trust, the remainder is paid to the charity or charities that have been identified in the trust document.
CRTs have long been a popular way to deal with highly appreciated assets. The idea is that the donor transfers the assets to the CRT, which then sells the property. No capital gains or investment income are recognized by the CRT because it is exempt from tax.
Purpose of the CRT strategy as it relates to the NIIT: To harbor net investment income in a tax-exempt vehicle while spreading income distributed to the beneficiary over a longer period of time in an effort to keep MAGI below the threshold amount.

38. Minimizing MAGI (Charitable IRA Rollover Provision)
The charitable IRA rollover provision allows for distributions directly from an IRA to a 501(c)(3) organization.
Example: Instead of taking a $50,000 IRA distribution, Ben arranges for the $50,000 to be transferred directly to a local charity. The $50,000 never enters his MAGI calculation and Ben does not receive a charitable deduction. Keeping MAGI low helps to alleviate the NIIT and also allows Ben to take advantage of more 2% itemized deductions on his Schedule A.

39. Minimizing MAGI (Above-the-line deductions)
The following above-the-line deductions are allowed before determining MAGI and therefore could reduce the income exposed to the NIIT:
Deductible contributions to a health savings account
Deductible contributions to self-employed retirement accounts
Deductible contributions to a traditional IRA

40. AMT Planning
The AMT system was designed in 1969 to prevent the very wealthy from using a variety of special tax incentives to avoid paying income tax.
Planning for AMT has become increasingly difficult and it requires examining multi-year scenarios.
Exemptions for 2013 are $51,900 (S) and $80,800 (MFJ). Exemption phases out as income increases.

41. AMT Planning What causes a taxpayer to be subject to AMT?
Large state and local tax or property tax deductions
Large long-term capital gains or qualified dividends
Large miscellaneous itemized deductions
Large amounts of tax-exempt income that is not exempt for state tax purposes
Large number of dependents
Tax-exempt income from private activity bonds
Home equity loan interest for expenses not used to buy, build, or significantly improve a primary or second home.

42. AMT Planning What can you do about it?
If you expect to be subject to AMT this year, but in a higher tax bracket next year, say 35%, consider accelerating ordinary and short-term gain income into the current year and deferring deductions into next year. Your accelerated income will be taxed at a 28% rate and your deferred deductions will be deductible at a 35% rate.
Consult your tax advisor to help you run various scenarios.

43. Estate and Gift Tax Planning
For 2013, the gift tax, estate tax, and GST tax exemption amounts are each at $5,250,000 and the tax for each is 40%.
For 2013, the annual gift exclusion is $14,000 per taxpayer.

44. Estate and Gift Tax Planning
Easy ways to transfer assets out of an estate:
Utilize the $14K annual exclusion. Each taxpayer can gift up to $14K per recipient in Example: A married couple has 2 grown children who are each married and each have 2 children. The couple can shift $224,000 out of their estate in 2013.
Payments of tuition directly to a school. This is a common planning tool for grandparents as there are no gift tax consequences.
Payment of medical expenses directly to the medical provider. Similar to tuition payments, these are not reportable as gifts.
Frontloading 529 plan contributions. A taxpayer can pre-pay 5 years worth of contributions into a 529 plan in one year, which equals $70K ($14K * 5) per taxpayer. A married couple could shift $140K to a grandchild’s 529 plan in one year and not pay gift taxes due to the ability to elect to spread the payments over 5 years.

45. Estate and Gift Tax Planning
Consider tools such as family limited partnerships to help your clients transfer wealth to family members at a discount.
Example: A widowed grandmother used $1 million of her gift tax exemption years ago. Now, with the increased $5.25 million exemption, she has the opportunity to gift another $4.25 million without paying gift tax. She will transfer land worth $620K and closely held stock valued at $5.8 million into an LLC, which she initially owned 100%. The LLC was valued by a qualified appraiser at $4.19 million, due to the lack of marketability and minority interest discounts. The grandmother shifted 95% of her LLC interests to her family members and reported a gift of $3.91 million. In short, she was able to transfer assets of $6.14 million to her family and out of her estate for a reportable gift of $3.98 million.
This is just one example of many ways to shift wealth out of one’s estate. There are many other options.

46. General Tax Planning Ideas
If you are generating a net operating loss, consider electing to carry it forward to offset future ordinary income at higher rates rather than electing to carry it back to offset income taxed at lower rates. However, always consider the time value of money. Is the tax savings more than what the money could earn if you go ahead and carry back the net operating loss and apply for a refund?
Consider donating appreciated stock to charity rather than selling the stock, paying capital gains tax, and donating the cash. Never donate depreciated stock to charity.
Always fund your retirement plan! Even if you think tax rates will rise, it is still better to reserve the money in an account that will grow tax free for multiple years.
Consider making a non-deductible contribution to a traditional IRA and rolling it over to a Roth IRA. There is no longer an AGI limit for Roth conversions, but the income tax will have to be paid in one year, rather than spreading over two years.

47. N.C. Tax Simplification and Reduction Act of 2013
On July 24, 2013 Governor Pat McCrory signed into law HB 998, The Tax Simplification and Reduction Act of Important changes to note are as follows:
The legislation replaces the graduated personal income tax rates with a flat tax of 5.8% during the 2014 tax year and 5.75% for post-2014 tax years (currently the personal income tax rates range from 6% to 7.75%);
increases the standard deduction amount to $15,000 for joint filers (currently $6,000), $12,000 for heads of household (currently, $4,400), and $7,500 for single taxpayers and married taxpayers filing separately (currently $3,000);

48. N.C. Tax Simplification and Reduction Act of 2013
limits itemized deductions to charitable deductions, personal residence interest, and real property taxes, but cap the deduction amounts for personal residence interest and real property taxes at $20,000. There would be no limit on charitable deductions; and
repeals the personal exemption (currently $2,500) and numerous other deductions, including $50,000 deductions for net business income. Other deductions, including the deduction for Social Security benefits, would be retained;

49. N.C. Tax Simplification and Reduction Act of 2013
eliminates the deduction of retirement income and severance wages (NOTE: remaining intact, North Carolina does not tax certain retirement benefits received by retirees of the State of North Carolina and its local governments or by United States government retirees, including military);
and the act repeals the estate tax, which is currently imposed at a maximum rate of 16%.

50. N.C. Tax Simplification and Reduction Act of 2013
Planning Ideas:
Consider advising clients to pre-pay property taxes in 2013 before the $20,000 limitation kicks in during You should take into account the AMT implications at the federal level while considering this.
For clients considering selling businesses in late 2013, it may be prudent to defer the sale until early A deferral of a $10,000,000 sale would save $195,000 in N.C. income tax.

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