Obama's Proposed Budget: Making the Death Tax More Deadly

So much for the "permanent" tax law changes that were just enacted a few months ago.  President Obama's new budget now includes an increase in the estate tax along with other measures to make it more difficult for families with larger estates to pass assets onto their children.

In January, the President and Republicans agreed to tax estates at 40% with an exemption of $5 million per person (indexed for inflation).  Obama's budget, however, proposes to raise the top rate to 45% and reduce the exemption to $3.5 million.  This new exemption level would not be indexed for inflation which means that over time, smaller estates would begin to be hit with an estate tax.

In addition, the budget makes proposed changes to utilizing short-term GRATs as well as making gifts of family limited partnerships--techniques which have been used for years to minimize estate and gift taxes. 

2012 Tax Relief Act Hammers Certain Trusts

Like many of the provisions of the 2012 Tax Relief Act that flew under the media radar, one aspect is particularly troubling.

To the casual observer, they were aware that for those with incomes above$450K they would be in the top tax bracket of 39.6% and subject to an increased capital gains rate of 20%--and that those making above $250K would be subject to the Obamacare 3.8% tax on investment income. 

What most didn't realize is that these taxes hit non-grantor trusts on any income that it does not distribute over just $11,950.  In other words, trusts that retain small amounts of income will get hit much hard and at an accelerated rate, even though its beneficiaries will be in a lower bracket.

While there are ways to navigate through these issues, careful consideration should be made as to how much should be distributed and when it should be distributed from the trust as there is always a tension between the current income beneficiaries and the remainder beneficiaries who stand to inherit what is left.

The biggest complication arises when you have a trust established for a spendthrift child or special-needs child who, under the terms of the trust, really isn't supposed to gain access to 100% of the trust's income.

2013 Tax Surprise--Everyone Pays More

While the media focused myopically on the impending changes in tax rates as part of the fiscal cliff negotiations, scant attention was given to the scheduled and automatic expiration of the payroll tax holiday--namely, an increase from 4.2% to 6.2%.

Because of this lack of coverage many low and middle-income Americans, contrary to what they had expected and understood, face a sober reality that their taxes will increase by a substantial degree.  It is estimated that this increase will result in an average of $2,000 in extra taxes for middle-income families during 2013.    

Notably, the tax burden will rise more for someone making $30,000 a year (1.7%) than it does for someone earning $500,000 a year (1.3%) 

Is the New $450,000 Threshold of "Increased" Taxes Political Fiction?

From the Wall Street Journal, The Stealth Tax Hike:

Anyone still need a reason to abandon "grand bargains" and deals negotiated between this President and GOP Congressional leaders? Here it is: The revival of two dormant provisions of the tax code means the much ballyhooed $450,000 income threshold for the highest tax rate is largely fake.

The two provisions are the infamous PEP and Pease, which aficionados of stealth tax increases will recognize immediately as relics of the 1990 tax increase. Those measures, which limit deductions and exemptions for higher-income taxpayers, expired in 2010. The Obama tax bill revived them this week. It isn't going to be pretty.

Under the new law, some of the steepest tax increases may fall on upper-middle class earners with incomes just above $250,000.

...

A store manager married to a dentist with a combined income of, say, $350,000 may pay a higher tax rate under the new law than if the tax code had simply reverted back to the Clinton-era rates that Mr. Obama championed. Those earning more than $450,000 would see their de facto tax rate rise to about 41% under the new law, not 39.6%. Add in the new ObamaCare investment taxes and the tax rate on interest income is close to 45%.

...

Democrats are advertising the higher $400,000-$450,000 threshold as a victory for affluent taxpayers in blue states. But with PEP and Pease these Democrats are hammering their own constituents via the backdoor.

If your wondering just how much your taxes will be affected in 2013 compared to 2012, the nonpartisan Tax Policy Center in Washington has updated an easy-to-use calculator that will help you estimate your 2013 tax bill. It offers results for typical taxpayers from the lowest to the highest incomes, and also has a feature allowing users to create their own example.  It’s available here.