There was a
recent change in the tax law that you might not be
familiar with - yet it may entitle you to
significant tax savings. Beginning January 1, 2008
and continuing through December 31, 2010 (unless
extended by Congress), a zero tax rate may apply to
long-term capital gain and dividend income that
would otherwise be subject to the lowest federal
income tax rates, 10% and 15%.
The new zero tax rate creates the opportunity for
eligible individuals to sell certain appreciated
assets at no tax cost. By working with you to ensure
that you take advantage of this new opportunity, if
available, we can help you pay less tax and preserve
more of your wealth.
The Zero Tax Rate
There are two questions we must ask to determine
whether a taxpayer is eligible for the new zero tax
rate.
- Is the taxpayer an individual
who has "adjusted net capital gain."
- If yes, is the individual eligible for the
zero tax rate?
Adjusted
net capital gain is, in essence, long-term capital
gain minus short-term capital losses, if any, plus
dividend income.
Planning Tip: There are
exceptions when calculating adjusted net capital
gain. Therefore, it is important that a
knowledgeable tax advisor assist you with this
calculation.
Who Gets the Zero Tax Rate?
Not surprisingly, determining whether someone is
eligible for the zero tax rate is a complex
calculation. We have tried to simplify it as
follows:
- Add all of your income to determine your
Adjusted Gross Income (AGI).
- Subtract exemptions and deductions from your
AGI to determine your taxable income.
- Subtract adjusted net capital gain from your
taxable income to determine your "other taxable
income."
- Is your other taxable income
less than the threshold of your
25% income tax bracket? If yes, subtract other
taxable income from your 25% tax rate threshold.
- The remainder is eligible for the zero tax
rate.
Planning Tip: Your income does
not have to be below the 25% tax rate threshold
for you to be eligible for the zero tax rate.
Even if your taxable income is significantly
higher than your 25% rate threshold, some of
your adjusted net capital gain may still be
eligible for the zero tax rate.
For 2008, the 25% tax rate threshold is:
- $32,550 for single taxpayers and married
taxpayers filing separate returns;
- $65,100 for married taxpayers filing joint
returns and surviving spouses; and
- $43,650 for heads of household.
Example
Suppose in 2008 Mr. and Mrs. Taxpayer have $105,000
of wages plus $120,000 long-term capital gain from
the sale of stock. Thus, their 2008 adjusted gross
income (AGI) is $225,000. If they have $65,000 in
personal exemptions and itemized deductions, their
2008 taxable income is $160,000 ($225,000 minus
$65,000).
From the formula above, the Taxpayers' other income,
after exemptions and deductions, is $40,000
($160,000 minus $120,000 adjusted net capital gain).
Subtracting this amount from their 25% threshold of
$65,100, the zero rate applies to $25,100 of their
adjusted net capital gain ($65,100 minus $40,000).
Thus, the zero rate would save them $3,765 ($25,100
x .15) of federal income tax. The balance of their
adjusted net capital gain ($120,000 minus $25,100)
would be subject to the 15% rate.
Planning Tip: If your taxable
income is less than your respective 25% rate
threshold, all of your adjusted net capital gain
will be subject to the zero tax rate.
Planning Tip: Conversely, if
your taxable income - other than adjusted net
capital gain - is equal to or greater than your
25% rate threshold, you will not be eligible for
the zero tax rate.
Planning Tip: You and your tax
advisors should pay careful attention to
year-end income and deduction timing. Careful
planning may create eligibility for the zero tax
rate.
Application of the "Kiddie Tax"
In establishing the zero tax rate, Congress was
concerned that taxpayers would transfer appreciated
assets to their young children to avoid tax on the
sale of those assets. Absent some limitation, the
children could then sell the assets at the zero tax
rate and avoid paying tax on the capital gain. A
limitation comes from Congress in the form of the
so-called "kiddie tax."
With the kiddie tax, a child must pay federal income
tax at his or her parents' highest rate on the
child's unearned income over $1,800. For tax years
before 2008, the kiddie tax applied only to children
under 14. However, while the zero tax rate is in
effect, the kiddie tax is extended to all children
under 18. In addition, while the child is a
full-time student, the kiddie tax now applies until
the child is 23 years old if the child's earned
income does not provide more than one-half of his or
her support.
Planning Tip: The opportunity
remains to transfer appreciated assets to
children, grandchildren or other family members
24 or older to take advantage of the zero tax
rate. The opportunity also remains with younger
children, but is limited. We can help clarify
your planning opportunities.
Conclusion
The zero tax rate presents a significant opportunity
for those individuals whose income, other than
adjusted net capital gain, is less than their 25%
income tax rate threshold - no matter how high their
total taxable income (including adjusted net capital
gain). The zero tax rate may also be available
through transfers to young adults and other
low-income taxpayers. Like with so many other areas,
your planning team should work together to ensure
that you take full advantage of the zero tax rate
without compromising your other planning goals and
objectives.
Chances are
great that you should have life insurance. Whether
you can afford to buy it and what kind you need are
just two of the many issues that confront us when we
consider life insurance.
There are few experiences more traumatic than trying
to figure out one's life insurance needs. Many of us
have a genuine fear of being underinsured,
especially in the days of lengthening life
expectancies and rising costs of living. How will my
family pay the mortgage, pay for college, etc., and
maintain the same standard of living should
something happen to me? Insurance isn't a gambling
proposition. But, alternatively, the insurance
consumer frequently feels pressure to buy more than
he or she needs.
"How much life insurance do I really need?"
Perhaps the soundest approach to purchasing life
insurance is to consider personal "needs." There are
three basic uses for life insurance.
Income Replacement ("How will my family pay
the bills if I die?")
Life insurance can replace lost income for those of
us who die unexpectedly. For example, what funds
will be available to pay everyday bills? In
determining the amount of life insurance necessary
for income replacement, consider the following
needs:
- A "transition" fund to pay at least six
months' bills during the grieving period;
- An "emergency find" for a catastrophic
illness or injury, sudden and unexpected
accident or casualty, financial collapse or the
like;
- Funds to pay off mortgages and other debts;
and
- Funds to supplement or replace Social
Security.
If you have
young children, also consider an amount sufficient
for child-rearing, college and post-graduate
expenses, career help and even the cost of
marriages.
Planning Tip: Consider life
insurance to replace income from the premature
death of a breadwinner spouse or parent. The
amount of insurance necessary should take into
consideration not only monthly living expenses,
but also transition and emergency funds, plus
child-related expenses.
Wealth Replacement ("How can my family
receive the full value of my assets?")
The traditional wealth replacement use for life
insurance was to replace wealth lost to the federal
estate tax. However, in 2008 the exemption to the
federal estate tax has increased to $2 million per
individual, $4 million per married couple. As a
result, fewer individuals are subject to federal
estate tax, and thus few individuals need life
insurance solely for the traditional wealth
replacement need.
But life insurance also satisfies other wealth
replacement needs. For example, many of our most
significant assets are tax-qualified plans (such as
IRAs, 401(k)s and pension plans). Because these are
a special class of assets, they are subject to
ordinary income tax when distributed to our
beneficiaries. Given the statistics that
beneficiaries often deplete these assets quickly,
they will incur significant income tax
in withdrawing these assets. Therefore, a million
dollar IRA may be worth only $650,000 after federal
income tax, less after state income tax. Realizing
this, many of us would benefit from life insurance
designed to replace this lost wealth.
Other wealth replacement needs for life insurance
include:
- Funeral and other last expenses; and
- Estate administration expenses, including
medical bills, hospital costs, decedent's debts
and bills, taxes, fiduciary's commissions,
attorney's fees and probate costs;
Wealth Creation ("What if I die before I build an
estate for my family?")
The third basic need for life insurance is the
creation of wealth. Examples of this need are
families who wish to add to their wealth for future
generations or to fund their philanthropic
objectives. Wealthy families often use life
insurance for the creation of additional wealth.
Other Uses for Life Insurance ("I didn't
know there were so many other situations where only
life insurance will assure me my goals will be
reached even if I die!")
Many individuals use life insurance as a funding
mechanism in other situations, including:
- buy-sell planning for business owners;
- key employee coverage;
- nonqualified deferred compensation;
- liquidity for state
death taxes; and
- inheritance equalization (for example, where
only one child works in the family business).
Planning Tip: Life insurance is
often the only vehicle that ensures
that you will have the necessary liquidity when
needed.
Irrevocable Life Insurance Trusts ("A little
planning can provide enormous tax savings.")
Life insurance proceeds are not subject to income
tax. However, if the insured owns the insurance
policy, these proceeds will be included in the
insured's gross estate and, therefore, be subject to
federal and/or state estate tax. One simple way to
avoid this result is to use a properly drafted and
maintained Irrevocable Life Insurance Trust (ILIT).
An ILIT that owns the life insurance can avoid
federal and estate tax on the life insurance
proceeds. Such a trust can also ensure that the life
insurance proceeds are available as you intended.
Planning Tip: Use an
Irrevocable Life Insurance Trust to purchase,
own and be the beneficiary of life insurance.
This will ensure that the life insurance
proceeds are not subject to estate tax.
Conclusion
Life Insurance is a unique asset that can provide
the highest degree of flexibility for changes in the
law or changes in your circumstances. Therefore the
quality of the life insurance agent and the life
insurance company you select are among the most
important choices you can make. We recommend that
this professional be part of your planning team to
help ensure that your life insurance is an integral
part of a comprehensive financial and estate plan.
To comply with the U.S. Treasury regulations, we
must inform you that (i) any U.S. federal tax advice
contained in this newsletter was not intended or
written to be used, and cannot be used, by any
person for the purpose of avoiding U.S. federal tax
penalties that may be imposed on such person and
(ii) each taxpayer should seek advice from their tax
advisor based on the taxpayer's particular
circumstances. |
