Best tool for proposed tax changes?

There are several current tax proposals. Among the many proposals is to increase capital gains taxes.

Currently, federal law imposes a maximum capital gains tax of 20%, plus a 3.8% surcharge on net investment income, for a total of 23.8%. However, under the proposals, to the extent a taxpayer’s income exceeds $1 million, capital gains would be taxed at the highest rate of ordinary income. This normal income cap will return to law before 2017, in another meaning, 39.6%. The surcharge on net investment income would be 3.8% on top of that for a total of 43.4%. This does not assume any state or local taxes.

Thus, for a person who can maintain his income below $1 million, his capital gain would be 23.8% or less. However, to the extent that income is more than $1 million, it will be taxed at a marginal rate of 43.4%. That’s nearly double the tax rate. Therefore, if they can spread out the taxes on the gains over several years, they may be able to reduce their taxable income so that it fits the million dollar threshold and is taxed at the lower level.

The Charitable Remaining Fund (“CRT”) is just such a tool. With a CRT, the donor gets a discount up front for the actuarial value of the remaining interest expected to go to charity. This should be a minimum of 10% of the contribution value. The value of the income interest can be as high as 90%. Therefore, if the donor contributes $1 million to the CRT and the actuarial value of the interest that goes to the charity is $100,000, the donor can take a $100,000 charitable deduction in the year of the donation to the CRT (according to typical AGI percentage restrictions).

Perhaps the best feature of a CRT is that it is a tax-exempt entity. Therefore, if the grantor contributes assessed assets and the CRT sells them (without prior obligation to do so), the CRT does not pay tax on the gain. However, when distributions are made to a donor or other recipient of income, those distributions are proportional to the income earned by the CRT.

The effect of this is to defer the gains until the grantor pays taxes on them at a much lower tax rate. The effect of this postponement can be greater in some circumstances. For example, let’s say your client, Tom Taxpayer, is nearing retirement. Tom has accumulated a large amount of stock on a very low basis. In his final year of business, Tom contributed $1 million of stock to CRT. He gets an income tax deduction in his last year of employment when his income is high and the deduction is more valuable. CRT sells the shares but does not pay tax on the gain because it is tax deductible. When Tom receives payments from the CRT when he retires, he is in a lower income tax bracket and pays tax at lower rates.

Now is the time to learn about CRT. This unique tool can be increasingly useful.

Stephen C. Hartnett, JD, LLM
Education Manager
American Academy of Estate Planning Lawyers, Inc.
9444 Balboa Street, Suite 300
San Diego, CA 92123
Phone: (858) 453-2128

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