1. Preparing for the 3.8% Health Care Surtax Tools, Tips, and Tactics Presented by: Your Firm Here

2. Personal Financial Planning Section Patient Protection and Affordable Care Act Supreme Court upheld the proposed tax increases that were part of the Patient Protection and Affordable Care Act (as amended by the Health Care and Education Reconciliation Act of 2010) (“ACT”). While certain elements of the legislation have already begun to take effect, some won’t begin until January 1, 2013. TAX ON EARNINGS Today, workers pay 1.45% of their wages into Medicare. Starting next year, high-income individuals will pay another 0.9 percentage points on their earned income over $200,000 ($250,000 if married). INVESTMENT INCOME To date has never been subject to the Medicare tax. Starting next year, high-income households will start paying a 3.8% surtax on at least a portion of their investment income, such as capital gains, dividends, and rental income. 2

3. Personal Financial Planning Section An additional 0.9% surtax on higher income households The tax applies to wages and self-employment income in excess of threshold. There is no employer match on the 0.9 percent tax. THRESHOLDS Single taxpayers Married taxpayers filing jointly $200,000 $250,000 Tax on Earnings 3

4. Personal Financial Planning Section Ron › Single taxpayer › Self-employed › $500,000 earnings Excess of Earnings $500,000 Threshold -$200,000 = $300,000.9% surtax would APPLY to $300,000 = $2,700 additional tax.9% surtax would APPLY to $300,000 = $2,700 additional tax Tax on Earnings - Example 4

5. Personal Financial Planning Section 3.8% Medicare Surtax - Overview Investment Income Beginning with the 2013 tax year, a new 3.8% Medicare “surtax” will apply to all taxpayers whose income exceeds a certain “threshold amount”. This new “surtax” will, in essence, raise the marginal income tax rate for affected taxpayers. Thus, a taxpayer in the 39.6% tax bracket (i.e. the highest marginal income tax rate in 2013) would have a marginal rate of 43.4%! 5

6. Personal Financial Planning Section Current Tax Rate Tax Rate in 2013+ Tax Rate in 2013+ (w/surtax) 10%15% 25%28% 31%34.8% 33%36%39.8% 35%39.6%43.4% NOTE: The chart above assumes that the 3.8% Medicare surtax would not begin to apply until a person’s taxable income reaches the 31% tax bracket (based on certain net investment income and itemized deduction assumptions). However, there are times when the 3.8% could apply to a person in a lower tax bracket (i.e. 15%, 28%) or may not apply to a person in higher tax brackets (31%, 36%, 39.6%). 3.8% Medicare Surtax - Overview 6

7. Personal Financial Planning Section APPLICATION TO INDIVIDUALS The Medicare Surtax is equal to: 1.“Net investment Income” OR 2. The excess (if any) of – -“ Modified Adjusted Gross Income (MAGI) -“Threshold amount” 3.8% X the lesser of 1.Net Investment Income OR 2. The excess (if any) of – -“Modified Adjusted Gross Income (MAGI) -“Threshold Amount” 3.8% Medicare Surtax - Overview 7

8. Personal Financial Planning Section APPLICATION TO ESTATES AND TRUSTS The Medicare Surtax is equal to: 1.“Net investment Income” OR 2. The excess (if any) of – -“ Modified Adjusted Gross Income (MAGI) -“Threshold amount” 3.8% X the lesser of 1.Undistributed “net investment income” for such taxable year OR 2. The excess (if any) of – -“Adjusted Gross Income” (as defined in section 67)) for such taxable year, over the dollar amount at which the highest tax bracket in section 1(e) begins for such a taxable year 3.8% Medicare Surtax - Overview 8

9. Personal Financial Planning Section 3.8% Medicare Surtax - Overview Three critical terms associated with the 3.8% Medicare Surtax: Net Investment Income Threshold Amount Modified Adjusted Gross Income (MAGI) 9

10. Personal Financial Planning Section NET INVESTMENT INCOME Includes: Interest Dividends Annuity Distributions Rents Royalties Income derived from passive activity Net capital gain derived from the disposition of property Does NOT Include: Salary, wages, or bonuses Distributions from IRAs or qualified plans Any income taken into account for self- employment tax purposes Gain on the sale of an active interest in a partnership or S corporation 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 3.8% Medicare Surtax - Overview 10

11. Personal Financial Planning Section Types of Income Subject to Surtax Subject to Surtax: Taxable Interest Dividends Annuity Income Passive Royalties Rents Exempt from Surtax: Wages Exempt Interest Active Royalties IRA Distributions 401(k) Distributions Pension Income RMDs Social Security Income 3.8% Medicare Surtax - Overview 11

12. Personal Financial Planning Section 3.8% Medicare Surtax - Overview “Threshold Amount:” the key factor in determining the “lesser of” formula for purposes of calculating the surtax. Threshold Amounts: Single taxpayers - $200,000 Married taxpayers - $250,000 Estates/Trusts - $11,650 (i.e. top income tax bracket in 2012) 12

13. Personal Financial Planning Section 3.8% Medicare Surtax - Overview “Modified adjusted gross income” (MAGI): 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 (i.e., Form 1040, Line 37) PLUS Net foreign earned income exclusion (i.e. gross income excluded under the foreign earned income exclusion less certain deductions or exclusions that were disallowed due to the foreign earned income exclusion 13

14. Personal Financial Planning Section Example 1 John Single Taxpayer $100,000 of Salary $50,000 net investment income MAGI is $150,000 3.8% Surtax would NOT apply MAGI is less than threshold 3.8% Medicare Surtax - Overview 14

15. Personal Financial Planning Section Example 2 Linda Single taxpayer $0 employment income $225,000 net investment income Excess of MAGI Threshold 3.8% Surtax would apply to $25,000 $225,000 -$200,000 = $25,000 3.8% Medicare Surtax - Overview 15

16. Personal Financial Planning Section Example 3 Tina & Terry Married, filing jointly $300,000 combined salary $0 net investment income 3.8% Surtax would NOT apply Wages Exempt 3.8% Medicare Surtax - Overview 16

17. Personal Financial Planning Section Example 4 Peter & Paula Married, filing jointly $400,000 salary income $50,000 net investment income 3.8% Surtax would apply to $50,000 3.8% Medicare Surtax - Overview 17

18. Personal Financial Planning Section Example 5 Sarah & Scott Married, filing jointly $200,000 salary income $150,000 net investment income Excess of MAGI Threshold 3.8% Surtax would apply to $100,000 $350,000 - $250,000 =$100,000 3.8% Medicare Surtax - Overview 18

19. Personal Financial Planning Section Example 6 Randy – Age 70 Single taxpayer $200,000 investment income $125,000 RMD from his IRA Excess of MAGI Threshold 3.8% Surtax would apply to $125,000 $325,000 - $200,000 =$125,000 3.8% Medicare Surtax - Overview 19

20. Personal Financial Planning Section Example 7 David & Veronica Married, filing jointly $100,000 pension income $150,000 IRA income $25,000 tax-exempt interest $0 net investment income 3.8% Surtax would NOT apply 3.8% Medicare Surtax - Overview 20

21. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “Net Investment Income” Municipal Bonds Tax-deferred annuities Life insurance Rental real estate Oil & Gas investments Choice of accounting year for estate/trust Timing of estate/trust distributions 21

22. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “Net Investment Income” Municipal Bonds Example: Jacob, a single taxpayer, on average has $180,000 of salary income, $5,000 of interest income and $15,000 of dividend income each year. Recently, Jacob inherited $1,000,000 from his uncle and has determined that he would like to invest the money either in: (a) taxable corporate bonds earning 7% or (b) tax-exempt municipal bonds earning 4.5%. Assuming that Jacob is in the 36% marginal income tax bracket for the 2013 tax year and lives in a state without an income tax, below is a summary of the after-tax yield on each investment: Corporate bondMunicipal bond 4.214% 4.5% {7% x [1 – (36% + 3.8%)]} 22

23. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “Net Investment Income” Tax-deferred Annuity Example : Lisa, a single taxpayer, has recently been approached by her financial advisor to consider investing in a tax-deferred non-qualified annuity. At the advice of her CPA, Lisa decided to invest $500,000 in a tax- deferred non-qualified annuity earning 5% per year. Assuming that Lisa has $200,000 of gross income and is in the 28% tax bracket for the next 10 years, below is a summary of the tax savings achieved by investing in a tax-deferred non-qualified annuity versus investing in a non-qualified diversified investment portfolio (i.e. a taxable brokerage account) earning 6% interest per year on a pre-tax basis. NOTE: The 31.8% income tax rate in the taxable brokerage account scenario is the sum of Lisa’s marginal income tax rate (28%) plus the 3.8% surtax because her gross income was over the threshold amount. 23

24. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “Net Investment Income” Life Insurance Example Tim, a married filing jointly taxpayer, recently paid a $250,000 single premium to purchase a $2,000,000 second-to-die whole-life policy. At the end of Year 10, Tim withdrew $50,000 from the policy’s cash value when it was worth $450,000. Given these facts, none of the $200,000 of earnings to-date ($450,000 current cash value - $250,000 initial premium), or any future earnings within the life insurance policy, are subject to the 3.8% surtax until Tim withdraws more than his initial single premium amount. Further, even if Tim withdraws earnings from the life insurance policy in a future tax year, none of the earnings will be subject to the 3.8% surtax, provided that Tim’s MAGI (which would include the earnings withdrawn from the life insurance policy) is below the “threshold amount” (i.e. $250,000 for married-filing-jointly taxpayers). 24

25. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “Net Investment Income” Rental Real Estate Example Jerry & Mary, married filing jointly taxpayers, have$50,000 of net royalty income annually from a gas well in Wyoming. In addition, Jerry has $100,000 in wages, Mary has $75,000 in wages and the both of them have $30,000 in dividend income each year. At the end of 2012, Jerry & Mary invested $275,000 into a residential real estate property. Based on past results, on average the property value increases by about 3.5% per year and the rental brings in about $5,000 of net income before depreciation. Assuming that the property is depreciated over a 27½-year life, the $275,000 investment will produce a $10,000 annual depreciation expense, resulting in a net rental loss of $5,000. This resulting net rental loss can then be used to offset Jerry & Mary’s net royalty income. Assuming that Jerry and Mary are in the 31% income tax bracket in 2013, below is a summary of the return on investment earned by Jerry & Mary’s from their rental real estate property. Property appreciation$9,625($275,000 x 3.5%) Net cash flow from rental5,000 Income tax savings from rental loss1,550($5,000 x 31%) Surtax savings from rental loss 190($5,000 x 3.8%) Total return on investment$16,365 Total return on investment (%)5.95%($16,365/$275,000) 25

26. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “Net Investment Income” Oil & Gas Investment Example George, a single taxpayer, recently invested $100,000 in a working interest in an oil well. According to the oil well driller’s accountants, 80% of the initial investment can be deducted in the first year as an “intangible drilling cost” (“IDC”). Assuming that George has $80,000 of net investment income subject to the 3.8% surtax and is in the 36% marginal income tax bracket, below is a summary of the total tax savings from the oil well investment. Income tax savings from IDC deduction$28,800[($100,000 x 80%) x 36%] Surtax savings from IDC deduction3,040[($100,000 x 80%) x 3.8%] Total tax savings$31,840 26

27. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “Net Investment Income” Choice of Accounting Year Example  On February 10, 2012, Patricia passed away. During the course of the 2012 tax year, Patricia’s estate had $50,000 of net investment income, $600 of miscellaneous non-investment income and no deductible expenses. In January 2013, the executor of Mary’s estate was trying to determine whether the estate should elect a calendar year-end (i.e. December 31, 2012) or a fiscal year-end (i.e. January 31, 2013).  Assuming a top marginal tax bracket amount of $12,000 in 2013, if the executor were to choose a calendar year-end of December 31, 2012, the estate would save $1,440 [($50,000 - $12,000) x 3.8%] in surtax. 27

28. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “Net Investment Income” Trust/Estate Distribution Example : During the 2013 tax year, the Smith Family Trust had $100,000 of net investment income and $19,900 of deductible expenses. The trustee is now trying to decide if a distribution of trust accounting income should be made to the trust beneficiaries. Assuming that each of the trust beneficiaries is currently in the 28% tax bracket and each has gross income below the Medicare surtax “threshold amount”, below is a summary of the tax savings that would occur if an $80,000 distribution was made: 28

29. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions Charitable Remainder Trusts (CRTs) Non-grantor Charitable Lead Trusts (CLTs) Installment Sales 29

30. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions Roth IRA Benefits Lowers overall taxable income long-term Tax-free compounding No RMDs at age 70 ½ Tax-free withdrawals for beneficiaries More effective funding of the “bypass trust” PURPOSE OF STRATEGY (as it relates to the 3.8% surtax): To lower MAGI below the “threshold amount” over the long-term. 30

31. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions In simplest terms, a traditional IRA will produce the same after-tax result as a Roth IRA provided that: The annual growth rates are the same The tax rate in the conversion year is the same as it will be in the withdrawal years 31

32. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions 32

33. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions Critical Decision Factors: Tax rate differential (year of conversion vs. withdrawal years) Use of “outside funds” to pay the income tax liability Need for IRA funds to meet annual living expenses Time horizon 33

34. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions Critical Decision Factors: Tax rate differential (year of conversion vs. withdrawal years) Use of “outside funds” to pay the income tax liability Need for IRA funds to meet annual living expenses Time horizon 34

35. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions The key to successful Roth IRA conversions is to keep as much of the conversion income as possible in the current marginal tax bracket However, there are times when it may make sense to convert more and go into higher tax brackets 35

36. Personal Financial Planning Section 10% tax bracket 15% tax bracket 25% tax bracket 28% tax bracket 33% tax bracket 35% tax bracket Current taxable income Target Roth IRA conversion amount “Optimum” Roth IRA conversion amount Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions 36

37. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions – Chart #1 (50-year old) 37

38. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions – Chart #2 (50-year old) 38

39. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions – Chart #3 (50-year old) 39

40. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions – Chart #4 (70-year old) 40

41. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions – Chart #5 (70-year old) 41

42. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Roth IRA Conversions – Chart #6 (70-year old) 42

43. Personal Financial Planning Section A Charitable Remainder Trust (CRT) is a split interest trust consisting of an income interest and a remainder interest. During the term of the trust, the income interest is usually paid out to the donor (or some other named beneficiary). At the end of the trust term, the remainder (whatever is left in the trust) is paid to the charity or charities that have been designated in the trust document. PURPOSE OF STRATEGY (as it relates to the 3.8% surtax): To harbor “net investment income” in a tax-exempt environment while at the same time leveling income over a longer period of time to keep MAGI below the “threshold amount”. Planning Around the Surtax Strategies for Reducing “MAGI” Charitable Remainder Trust 43

44. Personal Financial Planning Section Donor (Income Beneficiary) Public Charity (Remainder Beneficiary) Transfer of highly- appreciated assets Donor receives an immediate income tax deduction for present value of the remainder interest (must be at least 10% of the value of the assets originally contributed) At the donor’s death (or at the end of the trust term), the charity receives the residual assets held in the trust Annual (or more frequent) payments for life (or a term of years) CRT Planning Around the Surtax Strategies for Reducing “MAGI” Charitable Remainder Trust 44

45. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Charitable Remainder Trust Two Main Types of CRTs Charitable Remainder Annuity Trust (CRAT) – the beneficiaries receive a stated amount of the initial assets each year The amount received is established at the beginning of the trust and will not change during the term of the trust regardless of investment performance (unless inadequate investment performance causes the trust to run out of assets) Charitable Remainder Unitrust (CRUT) – the income beneficiaries receive a stated percentage of the trust’s assets each year. The distribution will vary from year to year depending on the investment performance of the trust assets and the amount withdrawn 45

46. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Charitable Remainder Trust Special Considerations Annual payout can neither be less than 5% nor more than 50% The present value of the remainder interest must be at least 10% of the value of the assets contributed to the trust The trust term cannot be more than 20 years (if a term interest is used) 46

47. Personal Financial Planning Section A Charitable Lead Trust (CLT) is a split interest trust consisting of an income interest and a remainder interest. During the term of the trust, the income interest is paid out to a named charity. At the end of the trust term, the remainder (whatever is left in the trust) is paid to non-charitable beneficiaries (e.g. children of the donor) that have been designated in the trust document. PURPOSE OF STRATEGY (as it relates to the 3.8% surtax): To offset “net investment income” against charitable deductions dollar-for-dollar in a tax-efficient manner. Planning Around the Surtax Strategies for Reducing “MAGI” Charitable Lead Trust (CLT) 47

48. Personal Financial Planning Section 48 Donor (Income Beneficiary) Public Charity (Income Beneficiary) Transfer of cash, stock and/or other assets At the donor’s death (or at the end of the trust term), the remainder beneficiaries receive the residual assets held in the trust Annual (or more frequent) payments for life (or a term of years) CLT Donor’s Children (Remainder Beneficiary) Planning Around the Surtax Strategies for Reducing “MAGI” Charitable Lead Trust (CLT) 48

49. Personal Financial Planning Section Planning Around the Surtax Strategies for Reducing “MAGI” Charitable Lead Trust (CLT) Two Main Types of CLTs Charitable Lead Annuity Trust (CLAT) – the charitable beneficiary receives a stated amount of the initial trust assets each year The amount received is established at the beginning of the trust and will not change during the term of the trust regardless of investment performance (unless inadequate investment performance causes the trust to run out of assets) Charitable Lead Unitrust (CLUT) – the charitable beneficiary receives a stated percentage of the trust’s assets each year. The distribution will vary from year to year depending on the investment performance of the trust assets and the amount withdrawn 49

50. Personal Financial Planning Section An installment sale is a type of sale in which the seller sells an asset to another person in exchange for a promissory note paid over a period of time. If executed correctly, the taxable gain recognized by the seller will be deferred until payments are made on the principal of the note. PURPOSE OF STRATEGY (as it relates to the 3.8% surtax): To level “net investment income” over a longer period of time so as to keep MAGI below the “threshold amount”. Planning Around the Surtax Strategies for Reducing “MAGI” Installment Sale 50

51. Personal Financial Planning Section 51 SellerBuyer Sale of highly-appreciated asset Promissory note paid over a period of years Taxable gain is deferred until payments on principal are made Planning Around the Surtax Strategies for Reducing “MAGI” Installment Sale 51

52. Personal Financial Planning Section Required Disclosure Under Circular 230 Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party. For discussion purposes only. This work is intended to provide general information about the tax and other laws applicable to retirement benefits. The author, his firm or anyone forwarding or reproducing this work shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this work. This work does not represent tax, accounting, or legal advice. The individual taxpayer is advised to and should rely on their own advisors. 52

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