Series: Proactive Planning in Preparation for 2013 Post –Election: Now What? How CPA Financial Planners Can Advise T

1. Series: Proactive Planning in Preparation for 2013Post –Election: Now What? How CPA Financial Planners Can Advise Their Clients Lyle Benson, CPA/PFS Robert Keebler, CPA, MST, AEP Ted Sarenski, CPA/PFS Scott Sprinkle, CPA/PFS

2. Introductions Lyle Benson, CPA/PFS, President, L.K. Benson & Co. Robert S. Keebler, CPA, MST, AEP (Distinguished), Keebler & Associates, LLP Ted Sarenski, CPA/PFS, President, Blue Ocean Strategic Capital, LLC Scott Sprinkle, CPA/PFS, Partner, Sprinkle Financial Consultants, LLC

3. Agenda • Setting the stage • Possible scenarios • Proactive planning opportunities • Income tax • Estate, gifts and trusts • 3.8% Medicare surtax • Specific planning techniques • How these CPAs will react timely based on various outcomes • Practice management & client communication tips • Educate, educate, educate • Plan now to be able to trigger action based on future outcomes

4. Setting the Stage

5. 2013 Tax Changes (if no action is taken) • Income Tax • Bush tax cuts expire: increase in ordinary income, capital gains, and qualified dividend rates • 3.8% Medicare surtax on net investment income of high-income individuals (MAGI > $200k single, $250k MFJ, $125k MFS) • 0.9% increase in Medicare payroll tax for high earners • Marriage penalty relief expires • Estate Tax • $5 million exemption reverts back to $1 million • Increase in estate tax rate from 35% to 55% • Gift Tax • $5 million exemption reverts back to $1 million

6. Comparison of 2012 vs. 2013 Tax Rates Ordinary Income Long-Term Capital Gains

7. Political Environment • Uncertainty = Flexibility • Post-Election • Unlikely to have any certainty before year-end • Start planning now, gathering data, preparing projections, drafting estate documents, etc. • President Obama’s budget proposal • Reinstatement of personal exemption phaseouts and itemized deduction phaseouts • Attack on itemized deductions: mortgage interest, charitable contributions, miscellaneous itemized deductions • Above-line-deductions: health care, retirement plan contributions, education expenses • Fiscal cliff • Looming tax law changes or extensions before year-end

8. Proactive Planning OpportunitiesIncome Tax

9. Income Tax Planning Opportunities in 2012 • Gain harvesting • Loss harvesting • Income shifting to junior generations • Roth IRA conversions • Other income tax planning ideas

10. Income Acceleration and Planning • Added dynamics of President’s proposal • Requires min 30% effective rate for those with income over $1 million annually • Harvesting gains • Last quarter of the year • Not affected by 30-day wash sale rules • Monitor elections for deemed sales • Comp and benefit issues • Exercise stock options • Pay bonuses before year-end • Deferred compensation elections (Don’t necessarily forego deferral accounts, particularly when there are matching provisions. Educate your clients and consider the political landscape.) • Roth conversions

11. Income Acceleration and Planning • Cash basis taxpayers • Accelerate billings • Other income acceleration ideas • Accrue bond interest in 2012 versus 2013 • Accelerate installment payments • Other planning • Re-allocation of portfolio based on tax changes (qualified plan versus non-qualified plans, etc.) • AGI planning between 2012 and 2013 to effectively manage the new 3.8 percent Medicare tax in 2013

12. Gain Harvesting • Sell assets with long-term capital gains in 2012 to take advantage of low 2012 rates • Repurchase same or similar assets • Sell assets whenever you would have sold them otherwise

13. Gain Harvesting - Tradeoffs • On the surface, it appears that taxpayers should always harvest gains • However, harvesting gains introduces a tradeoff between lower tax rates versus the loss of tax deferral • Tax is paid at a lower rate, but it is paid sooner • Need to determine a crossover point at which selling sooner makes more sense • A way to conceptualize this would be to use a return on investment (ROI) approach

14. Gain Harvesting - When to Harvest? • Very short time horizon • Loss harvesting will almost always be favorable because the benefit of tax deferral is small • Very long time horizon • Loss harvesting will almost always be unfavorable because the benefit of tax deferral is large • Taxpayer in the 0% long-term capital gains bracket in 2012 • Gain harvesting will always be favorable from a tax perspective because it gives you a free basis step-up

15. Gain Harvesting - When to Harvest? • Taxpayer plans to die with assets and pass them on to heirs with a stepped-up basis • Gain harvesting unfavorable because any gain would have been wiped out at death • Taxpayer has realized loss carryovers from prior years • Losses would be better used to offset gains in later years when long-term capital gains rates are higher

16. Loss Harvesting – Key Issues • “Wash sale” rule (IRC §1091) • Diminishing value of capital losses • Inefficiency of capital loss offsetting

17. Loss Harvesting – “Wash Sale” Rule (IRC §1091) • Capital losses are denied to the extent that a taxpayer has acquired (or has entered into a contract or option to acquire) a “substantially identical” stock or securities within a period beginning 30 days before the sale and ending 30 days after the sale of a stock which was sold at a loss (i.e. “loss stock”) • This rule also applies to ETFs and index funds • Disallowed loss on “loss stock” is added to the cost basis of the new stock • The holding period of the “loss stock” is carried over to the new stock

18. Loss Harvesting – Inefficiency of Capital Loss Harvesting • Loss Harvesting – Inefficiency of Capital Loss Harvesting • In general, capital losses are more tax effective if they can be used to offset income taxed at higher tax rates (e.g. short-term capital gains and ordinary income) • Thus, long-term losses used against short-term gains are more tax-efficient than short-term losses being used against long-term capital gains

19. Loss Harvesting Strategies • Buy stock of similar company • Double-up “loss stock” – wait 31 days • Double-up “loss stock” – enter into “cashless collar” • Buy call option at-the-money

20. Income Shifting to Junior Generations • Shift income to younger family members to reduce income taxes • Considerations • Asset protection • Kiddie tax • Potential taxable gift • Children use income to invest or purchase insurance

21. Roth IRA Conversions – Benefits • Lowers overall taxable income long-term • Tax-free compounding • No RMDs at age 70½ • Tax-free withdrawals for beneficiaries • More effective funding of the “bypass trust”

22. Roth IRA Conversions – Types • Strategic conversions – Take advantage of a client’s long-term wealth transfer objectives • Tactical conversions – Take advantage of short-term client-specific income tax attributes that are set to expire (e.g., low tax rates, tax credits, charitable contribution carryovers, NOL carryovers, etc.) • Opportunistic conversions – Take advantage of short-term stock market volatility, sector rotation and rotation in asset classes • Hedging conversions – Take advantage of projected future events that will result in the client being subject to higher tax rates within the near future

23. Itemized Deduction Planning • President’s proposal will limit itemized deductions to 28% -- and reinstate phaseouts • Accelerate itemized deductions in 2012 • Set up donor advised funds and fund future year’s charitable contributions in 2012 • Accelerate miscellaneous itemized deductions by prepaying expenses to get above the 2% limit • Interest rates at historically low levels • Look at the clients Form 1098 and mortgage statement • Discuss their refinancing strategy • Evaluate all of the client’s debt • Alternative minimum tax situation • Consider prepaying real estate taxes and personal property taxes

24. Proactive Planning Opportunities3.8% Medicare Surtax

25. 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%!

26. 3.8% Medicare “Surtax” Overview 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%).

27. 3.8% Medicare “Surtax” Overview APPLICATION TO ESTATES AND TRUSTS The Medicare Surtax is equal to: • “Net investment Income” • OR • 2. The excess (if any) of – • “Modified Adjusted Gross Income (MAGI) • “Threshold amount” • 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% X the lesser of

28. 3.8% Medicare “Surtax” Overview Three critical terms associated with the 3.8% Medicare surtax: • “Net investment income” (NII) • “Threshold amount” (TA) • “Modified adjusted gross income” (MAGI) 28

29. 3.8% Medicare “Surtax” Overview NET INVESTMENT INCOME • 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 • Includes: • Interest • Dividends • Annuity Distributions • Rents • Royalties • Income derived from passive activity • Net capital gain derived from the disposition of property

30. 3.8% Medicare “Surtax” Overview Types of Income Subject to Surtax • Exempt from Surtax: • Wages • Exempt Interest • Active Royalties • IRA Distributions • 401(k) Distributions • Pension Income • RMDs • Social Security Income • Subject to Surtax: • Taxable Interest • Dividends • Annuity Income • Passive Royalties • Rents

31. 3.8% Medicare “Surtax” Overview “Threshold amount”: is 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)

32. 3.8% Medicare “Surtax” Overview “Modified adjusted gross income” (“MAGI”): is 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)

33. Proactive Planning OpportunitiesEstates, Gifts, and Trusts

34. Estate & Gift Tax Planning • 2012 Estate/gift tax exemption linked at $5,120,000 • President’s Proposal: • Estate/GST $3.5 million exemption • Gift tax $1 million exemption • Rates jump from 35% to 45% • Retain portability • Disregard valuation discounts • Limit GRAT to 10-year term (zeroed out GRAT goes away) • Limit GST to 90 years – dynasty trusts no longer viable • Grantor trust benefits go away • Republican Proposals: • Status quo - keep $5 million+ exemption for estate and gift • If nothing passes: • $1 million exemption and 55% rate

35. Estate & Gift Tax Planning • Clients who can benefit most from planning • Elderly or ill, those who live in a state where state estate tax is decoupled from fed, clients who have asset protection needs, non-married same sex couples and wealthy • Impediment towards getting your clients to take action • Complexity (setting up trusts, etc.), cost of advisors, appraisals, etc., disbelief that changes are going to take place, uncertainty • Advisors need to help their clients understand the detriments to not planning ahead and taking action when necessary (run projections and show them the impact)

36. Estate & Gift Tax Planning • Start now! Use up exemption in 2012 • Some techniques take months to implement (GRATs, IDGTs), etc.) • Need to start now to educate clients, draft documents, prepare valuations, etc. • Income generation through CRUTs • Opportunities with low interest rates (GRAT) • Asset efficiency implications of gifting • Drafting to gift but not gift

37. Estate & Gift Tax Planning • Beware of large outright gifts • They are not protected from creditors claims and the remainder is not kept in the family • Reasons to gift now: • Save estate tax (federal and state) • Asset protection (if via trust) • Grandfather for GST • Grandfather for grantor trust changes • Lock in discounts • Remove appreciation from estate • Cash flow planning and running of projections is essential before taking action (create plan to ensure client is comfortable before triggering)

38. Maximize Gifting Opportunities in 2012 • General Gifting Considerations • The annual gift tax exclusion is $13,000 in 2012. • The gift tax rate is 35% for 2012 and scheduled to increase to 55% for 2013. • The lifetime gift tax exemption is $5,120,000 for 2012 and scheduled to decrease to $1 million in 2013. • Planning suggests making significant gifts in 2012. • Valuation discounts remain available under the law. Legislation has been proposed to limit discounting in transfers to family members – nothing has been enacted to date. • For the most part, state gift taxes are not an issue, since only Connecticut and Puerto Rico presently have independent gift taxes.

39. Maximize Gifting Opportunities in 2012 • General Gifting Considerations • The increased gift tax exemption provides an excellent opportunity for persons involved in same sex relationships, civil unions, common law marriages not recognized as valid marriages and similar relationships to make significant gifts to their intended beneficiaries. The Federal Defense of Marriage Act denies the federal gift and estate tax marital deductions for persons who are not of opposite sex in a legal marriage. • Bear in mind that property transferred by gift requires a carryover of the donor’s basis to the donee whereas property transferred at death permits a stepped-up basis to date of death value.

40. Maximize Gifting Opportunities in 2012 • General Gifting Considerations • Consider making gifts of low basis and/or dividend-producing property to persons who are in lower tax brackets (the 10% and 15% brackets) and who are not subject to the Kiddie Tax. These persons may be in the zero % tax bracket for 2012 with respect to their receipt of qualified dividends and realization of long-term capital gains. • Payments of tuition directly to an education provider and medical expenses directly to a medical care provider are not considered gifts at all. • Consider gifts to grandchildren. The generation-skipping transfer tax exemption is $5,120,000 in 2012 – and scheduled to be reduced to approximately $1,400,000 in 2013.

41. Maximize Gifting Opportunities in 2012 • Loans to Family Members • With interest rates at or near record lows, an excellent estate reduction technique involves making loans to one's children or grandchildren.

42. Planning Strategies: Sale to an Intentionally Defective Grantor Trust • Overview • The grantor creates a trust for the benefit of family members, and sells assets to the trust in exchange for a long-term installment note. The sale is made for fair market value per appraisals, etc., (including valuation discounts) so that the sale by the grantor to the trust is not treated as a gift to the trust beneficiaries. • How the Trust is Designed and Created • The trust is drafted to treat the grantor as the owner of the trust for income tax purposes, but not for estate tax purposes. This is accomplished by including certain grantor-retained administrative powers in the trust which cause the grantor to be treated and taxed for income tax purposes as the trust owner but not to be treated as the trust owner for estate tax purposes.

43. Planning Strategies: Sale to an Intentionally Defective Grantor Trust • Sale of Assets to the Trust • The sale of assets by the grantor to the trust avoids capital gain taxes, and the note interest (at required IRS interest rates) payable to the grantor from the trust is not subject to income tax. The transaction is treated as a sale by the grantor to him or herself. • Appreciation on the assets sold by the grantor to the trust grows outside the grantor’s estate. • If the grantor dies before the note is paid in full, only the unpaid balance of the note is included in the grantor’s estate.

44. Planning Strategies: Sale to an Intentionally Defective Grantor Trust • The Seed Money Gift Requirement • The only gift tax element of this transaction arises from the requirement that the trust must be capitalized (“seeded”) with sufficient equity assets (other than the assets acquired from the grantor in exchange for the note) to establish the independence of the trust from the assets sold by the grantor to the trust. The capitalization is generally 10% of the value of the installment note to create a debt to equity ratio within the trust of 10:1. • Have the Grantor Pay the Income Tax • The trust grantor may pay the income tax on the trust’s income from the grantor’s own funds without having such payment be characterized as a gift to the trust beneficiaries.

45. Transferring Wealth with Potentially No Gift Tax Cost: Using the GRAT • What is a GRAT? • The GRAT is an irrevocable trust to which the trust grantor transfers property while retaining the right to receive an annuity interest for a fixed term of years. • When the term of years expires, the property passes to the designated remainder beneficiaries of the trust. • How a GRAT works • The advantage of GRATs is the ability of the grantor to transfer property to the remainder beneficiaries at a significantly reduced gift tax cost, since the actuarial value of the grantor’s retained interest is subtracted from the fair market value of the trust property to determine the gift tax value of the transfer.

46. Multi - Generation-Skipping Transfer Tax Planning: Using Dynasty Trusts • The GST tax exemption may be used affirmatively to create a Dynasty Trust. • Dynasty Trust provides for life estates in property for every generation of beneficiaries. • A Dynasty Trust is typically structured to last for the maximum period of time permitted by state law. • If a Dynasty Trust is created in a state that has abolished the rule against perpetuities, and funded with an amount equal to the maximum available GST tax exemption of the transferor, the trust property will not be subjected to any further estate, gift or GST tax liabilities (assuming the trust principal is not distributed to the beneficiaries).

47. Multi - Generation-Skipping Transfer Tax Planning: Using Dynasty Trusts • Given the $5,120,000 lifetime gift tax exemption available in 2012, this may be an ideal time to consider the Dynasty Trust planning opportunity. • The Dynasty Trust offers the additional attraction of asset protection for future generations, since no beneficiary of the trust is the “owner” of any of the trust assets, so that creditors of beneficiaries will be unable to reach such assets. • Proposed legislation suggests limiting the duration of the Dynasty Trust to a 90-year life, after which time the trust property would be required to be distributed to the trust beneficiaries and ultimately subjected to transfer taxation.

48. Spousal Lifetime Access Trust (SLAT) • Purpose: • Tax planning: To give away property for transfer tax purposes while still retaining the possibility that distributions could be make to the spouse as beneficiary of the SLAT for benefit of the family • Asset Protection: If neither spouse is a trustee, and the only distributions that the surviving spouse can receive are at the sole discretion of the trustee, creditors generally cannot reach the trust assets. • Neither spouse retains interest in the SLAT; excluded from gross estate for federal tax purposes

49. Spousal Lifetime Access Trust (SLAT) • Using exemptions and avoiding estate tax • Use estate and gift exemptions discussed earlier to gift property to the SLAT • If the SLAT will be generation-skipping, consider allocating GST tax exemption to the trust to protect it from the GST tax • Surviving spouse’s interest should be limited to distributions at the discretion of an independent trustee • Otherwise, the interest could be included in the gross estate for estate tax purposes as an interest retained on the first-to-die’s life

50. Reciprocal SLATs • Trust provides reciprocal benefits for each spouse • If the trusts merely switch the surviving spouse as the spouse with access, the trust created will be includable in the gross estate for estate tax purposes. • However, you can avoid this reciprocal trust doctrine by making the two trusts sufficiently different, for example, by providing that one trust also give the spouse with access a limited power to appoint trust assets at death among a group of beneficiaries, while the other trust does not have such a provision.