Tax Planning after the American Taxpayer Relief Act of 2012

Abstract

For more than a decade taxpayers have enjoyed a 15-percent tax rate on long-term capital gains. The 15-percent rate was the lowest maximum tax rate on long-term capital gains since 1954. On January 2, 2013, Congress passed the American Taxpayer Relief Act of 2012 (ATRA). ATRA permanently increased the top capital gain tax rate to 20 percent (up from 15-percent) for single filers with taxable incomes above $400,000 and married couples filing jointly with taxable incomes exceeding $450,000. In addition as part of the Health Care legislation a new 3.8-percent Medicare surtax applies on net investment income, which includes capital gains.This results in an overall rate for higher-income taxpayers of 23.8 percent — a staggering 58.69-percent increase in 2013 from 2012 tax rates.The real kicker is the application of the capital gains tax rates to trusts. A trust is hit with the increased rate on any income the trust does not distribute over $11,950. This is significantly less than the $400,000/$450,000 taxable incomes from the American Taxpayer Relief Act of 2012 and the $200,000/$250,000 adjusted gross income from the Health Care legislation that is applicable to individuals. Many trusts accumulate capital gains in the trust and pay tax within the trust. Generally in the past the capital gain rate in the trust and the rate that would be applicable to the beneficiary were the same 15-percent. Therefore, generally the tax paid would be the same amount. Under the new rules in 2013 it is possible that the trust may be paying a capital gains tax at a 23.8-percent rate while the individual might be taxed at a 15-percent.With a 58.69-percent increase in 2013 and beyond, high-income taxpayers and trusts might look to ways to defer the recognition of the capital gain in the current tax year. In addition trusts in certain instances might look to have capital gains be part of the distributable net income (DNI). This article examines strategies to defer the recognition of the gain and the ability to monetize the position. Strategies that are examined are as follows:Variable Prepaid Forward ContractCollars Buy a Put and Sell a CallNonrecourse Loan against Publicly Traded StockEstablishing a Short-against-the-box after 1997Use a short-against-the-box to defer taxable gains from 2013 to 2014Charitable Gain Harvesting to offload gain to charitySale to an ESOPCharitable Remainder TrustsCapital Gains in a trust to be included in DNI.