Year-End Planning in 2012

Year-End Planning in 2012

As we enter the final weeks of 2012, financial and estate-planning advisors have rarely faced so many uncertainties surrounding tax and other relevant legislation, economic fluctuations and other determinative factors. Clients can, however, take certain action by the end of this year to help them take advantage of a few areas of certainty, in which wise planning of charitable gifts can pay off with immediate and, perhaps, future tax savings. 

Don’t Delay Charitable Gifts

Some advisors have questioned traditional income tax-planning strategies, which call for deferring income and accelerating deductions. The prospect of higher tax rates has prompted these practitioners to recommend accelerating income into this year to be taxed at lower rates, while putting off charitable gifts and other itemized deductions until next year, when they may be worth more if higher tax rates become a reality.1

There are at least three reasons why well-informed donors may not want to follow these recommendations: 

1. Whether tax laws change, there’s a negative cash flow impact if a charitable gift is delayed until 2013. This will result in a donor paying more taxes on the income not donated in 2012, while the enjoyment of savings from a deduction for a gift made next year will be delayed until April of 2014. We also know that the so-called “Pease Amendment” is scheduled to come back in force in 2013, resulting in those with higher incomes being required to reduce their itemized deductions by 3 percent of the amount their incomes exceed an applicable amount.

2. As I’ve noted in prior columns, both political parties have proposed changes in tax laws that would limit the future value of all itemized deductions, including charitable gifts. For example, a plan repeatedly put forward by the current administration would limit the value of charitable deductions to the 28 percent tax bracket. The result is that a person in the 35 percent tax bracket would save $3,500 in tax for a deductible $10,000 gift in 2012, while saving just $2,800 if such a limit is imposed. This would mean a real and substantial increase in the after-tax cost of giving, as the gift would have to be made from after-tax income to the extent of the 7 percent rate differential. This will be exacerbated if the top rate returns to 39.6 percent. Governor Mitt Romney has recently proposed limiting the total amount of itemized deductions that could be taken. One proposal was a $17,000 cap.2 This would completely eliminate the charitable deduction for higher income taxpayers making gifts of larger amounts.  


3. Even if tax rates are higher next year and deductions aren’t limited, no one knows what stock market values will be. Because donors are allowed to deduct the full value of qualified appreciated securities to reduce tax on income, the possibility of a reduction in market values next year may more than offset any possible value from deducting gifts next year. 

Offset Accelerated Income
With capital gains rates at a maximum of 15 percent this year, it may make sense for some clients to take gains before the end of the year, thereby generating additional adjusted gross income (AGI). If these clients then sell securities that have declined in value, they can use the resulting cash to make charitable gifts that will offset tax on gains realized and qualify for a deduction against the 50 percent of AGI limit, rather than 30 percent for gifts of non-cash property.

According to the Internal Revenue Service, in 2010, some 629,000 taxpayers took charitable deductions totaling $31 billion, which represented carryforwards from prior years when their gifts exceeded applicable AGI limits. If charitable deductions are limited in scope or value in future years, it may never be possible for some taxpayers to fully use accumulated carryforwards. Those with significant carryforwards might be wise to accelerate additional income into 2012 to help use as much of the carryforwards as possible, when they still have value. 

With stock market values in October 2012 at levels not seen since prior to the crash of 2007, many individuals have newly appreciated or “re-appreciated” assets that may yield little or no income. Using these assets to fund a charitable remainder trust (CRT) represents another way to generate an immediate income tax deduction, which can be used to offset other income accelerated into 2012. At the same time, the assets inside the trust can be sold and diversified without payment of capital gains tax, as the trust itself is a tax-exempt entity. This can represent a way to take profits on a tax-favored basis at current market levels rather than in the future, when values may have declined. 

If capital gains rates remain low, then based on the tier structure of income reporting mandated under Internal Revenue Code Section 664(b), the income received from a CRT will be taxed at the lower capital gains tax rate, to the extent it represents corpus generated by prior sales of appreciated assets inside the trust. The same is true of the portion of charitable gift annuity payments that represent return of the donor’s investment in the contract, to the extent that there was appreciation in the assets used to fund the gift annuity.

Take Advantage of High Exemption
For over a decade, the future of the federal estate tax has been uncertain. Political parties have sharply different strategies, with some calling for an increase in federal gift and estate taxes and others advocating their total elimination.  

One thing is sure, however. For the remainder of 2012, each individual can transfer up to $5.12 million free of gift tax or pass away leaving that amount tax-free to anyone he chooses. Assuming an individual plans to live through the remainder of the year, the lifetime giving option is the most viable. While one can always write a check or transfer assets to donees to take advantage of the current exemption, there are ways to accomplish this while also making significant charitable gifts.

The charitable lead trust (CLT) has continued to be a gift of choice for those who would like to combine philanthropy with family wealth-transfer planning. With interest rates remaining in the 1 percent range for purposes of determining the applicable federal midterm rate used to calculate gift tax deductions for gifts via CLTs, there may never be a better time to consider this vehicle.   

One strategy using a CLT is to determine the amount of gift tax exemption equivalent one has remaining and create a CLT that will transfer as much as possible, while absorbing the unused exemption. For example, suppose an individual has $1.5 million of gift tax exemption remaining. He could fund a charitable lead annuity trust paying 5 percent for five years with $2 million. The trust would make charitable distributions of $100,000 per year to fund a $500,000 commitment. The donor would file a gift tax return reporting a $2 million gift to heirs to be received in five years. The intervening gift to charity results in the reportable gift being reduced to $1.5 million, the amount that can be offset by the remaining exemption. When the dust settles, the donor has fulfilled a $500,000 charitable gift commitment over five years and transferred $2 million, or whatever other amount remains in the trust, to heirs at the end of five years, at the cost of $1.5 million in gift tax exemption.

Another way to use remaining gift tax exemption amounts is to fund a CRT or other split-interest gift with income to a loved one for a period of years or for life. This generates both a charitable deduction for the donor and a taxable gift to the income recipient. In the past, the gift tax owed on this gift may have deterred a donor. With the $5.12 million exemption now allowable, this type of gift may be a wise way to use part of that exemption.

Finally, for those with significant assets that include a primary or secondary residence, a little known way to generate current tax benefits while retaining use of property is through a gift of qualified real estate with a retained interest for life or term of years. Low interest rates make this type of gift especially attractive. For example, a donor might transfer a vacation home worth $1 million, with the right to use it for five years and thereby generate an immediate income tax deduction of $898,000. A 72-year-old could retain the use for the remainder of life and realize a deduction of $759,000. With proposed limits on the total amount of deductions under some proposals, 2012 may be the year to generate these types of deductions.


A Bird in the Hand

Now may be a time that the old adage, “A bird in the hand…” applies. The 19th century journalist Alphonse Karr wrote, “The more things change, the more they are the same.” He also observed what many might well take to heart today: “Uncertainty is the worst of all evils until the moment when reality makes us regret uncertainty.”



1. “4 Tax Moves to Gird for the Fiscal Cliff,” CBS Moneywatch (Oct. 1, 2012).

2. “Romney Floats Idea of Itemized Deduction Cap,” Wall Street Journal
(Oct. 2, 2012).