Disinherit the IRS with Year-End Tax Tips

Estate tax expert and author E. Michael Kilbourn today outlined a series of tax issues that investors need to understand as the year comes to an end.

According to Kilbourn, a “net investment income tax” (Obama Care/Medicare tax) is imposed on taxpayers with investment income (i.e., unearned income) whose modified adjusted gross income exceeds certain IRS set thresholds.  Commonly referred to as a Medicare contribution or surcharge, this tax is in addition to taxes imposed on a taxpayer’s earned income to fund social security and certain Medicare benefits. This net investment income (NII) tax is equal to 3.8% times the lesser of:

– The taxpayer’s net investment income, OR
– The excess of the taxpayer’s modified adjusted gross income (MAGI) over the threshold amount (e.g., $200,000 threshold for individuals, $250,000 threshold for married couples filing joint returns)

The NII tax of 3.8% also applies to most trusts and estates, and it is on the lesser of:

– The trust’s or estate’s undistributed net investment income, OR
– The excess of AGI over the dollar amount at which the highest income tax bracket applicable to a trust or an estate begins ($12,150 for 2014)

Because the surtax kicks in at $200,000/$250,000 of AGI before deductions, and the new 20% capital gains rate applies at $405,100/$457,600 of taxable income after deductions, anyone who faces the 20% rate must be subject to the surtax, for an actual rate of 23.8%. For those in the wide middle brackets – and subject to the 15% long-term capital gains rate – the Medicare surtax might apply (bringing the rate up to 18.8%).


In addition, Kilbourn warns taxpayers to be aware of the phase out of personal exemptions and itemized deductions for high-income taxpayers: If an a taxpayer’s AGI exceeds $254,200 for individuals and $305,050 for married filing jointly the phase outs are as follows:

– “Pease limitation” on itemized deductions
– Itemized deductions phased out by 3% of income over above threshold, up to 80% of total deductions
– Losing 3% of deductions at 33% rate equals a 1% increase in the tax rate
– Personal Exemption Phase out (PEP)
– Personal exemptions are phased out by 2% per $2,500 over above threshold, up to 100% of exemptions
– Marginal impact also approximately 1% increase in tax rate per exemption

To take advantage of capital gains and losses on stock sales for 2014, shares must be sold by December 31, 2014.  Be sure to take into account the capital gains rates and the 3.85 NII tax  – both discussed above. Kilbourn suggests examining your 2014 short-term gains and losses and long-term gains and losses and determining your capital gains and loss carry-forwards to ensure that you aligning them to the greatest extent possible.  Note that you may be able to use up the $3,000 of net capital losses to offset ordinary income for 2014 as well. Review with your advisors whether accelerating deductions into 2014, or postponing them to 2015, makes the most sense.

Do not forget about the Alternative Minimum Tax (AMT), he said. The AMT imposes a minimum tax rate over certain taxable income thresholds.  The exemption amounts for this year are $52,800 for individuals and $82,100 for married couples filing jointly, but note that these exemptions begin to phase out when alternative minimum taxable income reaches $117,300 for individuals and $156,500 for married couples filing jointly.  If you are subject to AMT and have the ability for defer income from 2014 to 2015 – to get below the threshold, consider deferring if you may not be subject to AMT in 2015.  If you are not subject to AMT, consider accelerating the types of income (i.e., exercising incentive stock options) that would have negative AMT consequences.  Also, consider accelerating deductions (i.e., property tax payments) that would not provide an equivalent tax benefit in a year in which you were subject to AMT.

To avoid capital gains taxes and the 3.8% surtax on net investment income, he suggests considering gifting appreciated property to charity (as opposed to selling the property and recognizing the gain, and contributing cash to charity).  You get an income tax deduction equal to the fair market value of the property (subject to AGI limitations), and the charity can sell the property and pay no capital gains because it is a tax-exempt entity.  It is critical that the appreciated property qualify as long-term capital gain property (held for more than one year); otherwise, your deduction will be limited to your basis in the property.