The most favorable estate and gift tax laws in recent history are set to expire after the end of the year, and for high net-worth individuals, the time for action is now.
For those who have unrealized capital gains in any asset, there may never be a better time to realize those gains, diversify portfolios or otherwise redeploy proceeds from asset sales. This could be the last chance to reposition one’s financial and estate plans on a tax-favored basis and to avail oneself of unprecedented planning opportunities.
The government needs revenue. Income taxes, capital gains and estate gift taxes are all in play, and are almost certain to increase. The election is over, and the status quo is maintained. Therefore, if major changes in one’s portfolio are warranted, taking action before Jan. 1, is advisable.
These are major areas to consider:
Tax Rates: If there’s no change in the tax law, long-term capital gains will rise from 15 percent to 20 percent and qualified dividends will lose their special status and will be subject to ordinary income tax rates. The maximum income tax rate will climb from 35 percent to 39.6 percent. What’s more, in 2013, a healthcare surtax of up to 3.8 percent on investment income will take effect.
Investment income is generally classified as capital gains, dividends, interest, annuity payments, royalties and rents. The healthcare surtax on investment income will generally apply to individuals with a gross income greater than $200,000 and married couples with combined gross incomes greater than $250,000.
As a result, in 2013, many “wealthy” taxpayers will incur a long-term capital gains rate of 23.8 percent rather than the present 15 percent, unless Congress deems otherwise. So tax efficiency — or seeking investments that minimize tax consequences — will once again be in vogue. It will be critical to pay attention to tax efficiency as well as how the assets are titled and which type of account (taxable or non-taxable) owns a particular investment asset.
Gifts: Today’s low interest rates and the high estate/gift tax exemption afford tremendous wealth/asset transfer opportunities for the rest of the year. This favorable environment allows high-net-worth individuals and business owners the opportunity to pass significant amounts of wealth/assets to anyone of their choice, free of gift and estate taxes.
Without a change in the estate and gift tax law in 2013, the estate tax exemption will revert to the 2002 exemption amount, resulting in more individuals’ estates being subject to estate tax. Estate and gift tax exemption amounts will decline from $5.12 million for an individual to $1 million, and the maximum tax and gift rates will increase from 35 percent to 55 percent.
Using assets that have the potential to appreciate (i.e. business interests, commercial property, etc.) maximizes the leverage and opportunities in gifting strategies. Moreover, because assets generally have depreciated over the last several years, utilizing such depreciated assets in gifting strategies is attractive.
Securities sales: In 2011, a provision requiring investors to adopt a consistent cost basis for valuing any securities they sold became effective. The new rule took effect in 2011 for stocks and Exchange Traded Funds bought and sold in 2011, and applies to mutual funds bought and sold in 2012.
To minimize taxes, it is often better to sell either the cheapest or most expensive shares. If the market value of the security has declined when it is sold, you may wish to use a cost basis that allows you to sell the lowest-cost shares. But if your investments have appreciated, selling your highest-cost shares can minimize your taxes.
In conclusion, we are confident that taxes will rise; therefore we urge that people with high net-worths and incomes consult with their financial adviser, accountant or attorney before year-end.
Orlando Roche is regional president, Miami-Dade County, for Sabadell Bank & Trust Co.