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September Newsletter 2012

September Newsletter 2012

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Published by Janet Barr

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Published by: Janet Barr on Sep 27, 2012
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Collaborative FinancialSolutions, LLC
CA Insurance License #0B33145Janet Barr, MS, ChFC, CLULPL Registered Principal206 E. Victoria StSanta Barbara, CA 93101805-965-0101
September 2012
Breaking Down the TaxpayingPopulation: Where Do You Fit In?Should You Make Large Gifts in 2012?Withdrawals from Traditional IRAsDo I have the right type of life insurance?
Breaking Down the Taxpaying Population: Where Do You Fit In?
See disclaimer on final page
From the Desk of Janet L. Barr,ChFC, CLU
Every quarter, theStatistics of IncomeDivision of the InternalRevenue Service (IRS)publishes financialstatistics obtained from taxand information returnsthat have been filed withthe federal government.Recent reports reflect datagleaned from 2009individual federal incometax returns. These reportsoffer a snapshot of how Americans break downas taxpayers.
Sources for data: 
IRS Statistics of Income Bulletin, Spring 2012 and Winter 2012,Washington, D.C.; IRS, Data on the 400 Individual Income Tax Returns Reporting the Largest Adjusted Gross Incomes, 2009 Update to Statistics of Income Bulletin, Spring 2003,Washington, D.C.
The big picture
Individuals filed roughly 140 million federalincome tax returns for 2009. Of those returns, just under 82 million (approximately 58%)reported federal income tax greater thanzero--representing the lowest percentage oftaxable federal income tax returns in 24 years.Half of all the individual income tax returns filedshowed adjusted gross income of under$32,396. (Adjusted gross income, or AGI, isbasically total income less certainadjustments--e.g., deductible contributions to atraditional IRA.) As a whole, this bottom-50%group accounted for just 13.5% of the total AGIreported on all federal income tax returns. Putanother way, 86.5% of AGI was concentrated inthe top 50% of returns filed.
A look at the top
What did it take in AGI to make the top 5% ofall individual filers? Probably not as much asyou think. If your return showed AGI of$154,643 or more, you would have been one ofthe almost 6.9 million filers comprising the top5%. This group reported about $2.5 trillion inAGI--31.7% of the total AGI reported--and wasresponsible for 58.7% of the total income tax forthe year.The roughly 1.3 million returns showing AGI ofat least $343,927 made up the top 1% of allfilers. This group reported 16.9% of total AGI; inother words, over $1.3 trillion of the $7.8 trillionin AGI reported was reported by the top 1% offilers. This group was responsible for 36.73% ofthe total income tax for the year.There were just under 138,000 tax returns withAGI exceeding $1.4 million. These returns,making up the top 0.1% of all filers (that's thetop one-tenth of one percent), accounted forapproximately $610 billion in AGI (about 7.8%of all AGI), and paid just over 17% of the totalincome tax.
Not all high-income returns showed tax
There were just over 3.9 million returns filedwith AGI of $200,000 or more. Of these returns,20,752 (0.529%) showed no U.S. income taxliability. Why did these returns show no incometax? The IRS report that provided the datanoted that high-income returns generally showno income tax as a result of a combination offactors, including deductions for charitablecontributions, deductions for medical and dentalexpenses, and partnership and S corporationnet losses.
Average tax rates
Simply dividing total income tax paid by totalamount of AGI results in the following averagefederal income tax rates:Top 0.1%--Average federal income tax rate of24.28%Top 1%--Average federal income tax rate of24.01%Top 5%--Average federal income tax rate of20.46%Top 10%--Average federal income tax rate of18.05%Top 50%--Average federal income tax rate of12.5%
Page 1 of 4
Should You Make Large Gifts in 2012?
Currently, the exemptions for federal gift tax,estate tax, and generation-skipping transfer(GST) tax are at historic highs, and the gift,estate, and GST tax rates are at historic lows.But, in 2013, the exemptions are scheduled tosubstantially decrease, and the tax rates arescheduled to substantially increase. This raisesthe question of whether 2012 might be a goodtime to make large gifts that take advantage ofthe current exemptions while they are stillavailable.
Looking into the future
When you transfer your property during yourlifetime or at your death, your transfers may besubject to federal gift, estate, and GST tax.(Your transfers may also be subject to statetaxes.) Currently, there is a basic exclusionamount (sometimes referred to as anexemption) that protects up to $5,120,000 fromgift tax and estate tax, a $5,120,000 GST taxexemption, and a top tax rate of 35%. Unlessnew legislation is enacted, in 2013 the gift taxand estate tax exemption will decrease to$1,000,000, the GST tax exemption willdecrease to $1,000,000 (as indexed), and thetop tax rate will increase to 55%.No one knows what the future holds for thesetaxes, but there is a lot of speculation aboutwhat Congress might do. Among the possiblescenarios, tax rates could increase andexemptions decrease, tax rates could decreaseand exemptions increase, or current tax ratesand exemptions could be extended. Thequestion then arises: "Should large gifts bemade in 2012 to take advantage of the large$5,120,000 exemption while it is still available?"To answer that question, you should generallyconsider the following: the size of your estateand the rate at which it can be expected togrow (or decrease), whether you can afford tomake large gifts, what the future of the transfertaxes might be, and whether "claw back" wouldapply in future years.
Claw back
Claw back refers to a situation where thebenefit of certain tax provisions is essentiallyrecaptured at a later time due to changes in taxlaw. There is some split in opinion as towhether claw back applies to the estate tax. Acouple of examples will illustrate the difference.
Assume the gift and estate tax change as currently scheduled in 2013 and claw back applies. Assume you make a taxable gift of $5 million in 2012 that is fully protected by your gift tax exemption and you have a taxable estate of $5 million when you die in 2013. Estate tax, after reduction by the unified credit but not the state death tax credit, is $4,795,000. The result is essentially the same as if you had not made the taxable gift in 2012 and your taxable estate is $10 million in 2013.
Assume the same facts as above,but with no claw back. Estate tax, after reduction by the unified credit but not the state death tax credit, would be $2,750,000. So, the federal estate tax is $2,045,000 lower if there is no claw back.
Guidelines for large gifts in 2012
If you expect that you can keep your estatedown to around $1 million ($2 million total forboth spouses if you are married) using annualexclusion gifts (generally, up to $13,000 perrecipient per year; effectively, $26,000 for giftsby married couples) and qualified transfersexclusion gifts for medical and educationalexpenses, there may be no advantage tomaking taxable gifts in 2012. If you have alarger estate, you may wish to consider makingtaxable gifts sheltered by exemptions in 2012,depending on your evaluation of how theguidelines here apply to your particularcircumstances.If you make taxable gifts sheltered by the giftand estate tax exemption in 2012, and the giftand estate tax rates later increase, theexemptions decrease, and there is no clawback, you may save gift and estate taxes bymaking the gifts in 2012. Even if there is clawback, your gift and estate taxes will probably beno worse than if you hadn't made the gifts. And,if the gift and estate tax rates later decrease orstay the same and the exemptions increase orstay the same, your gift and estate taxes willprobably be no worse than if you hadn't madethe gifts.If you make generation-skipping transferssheltered by the GST tax exemption in 2012,and the GST tax rate later increases and theexemption decreases, you may save GST taxby making the GST in 2012. Even if the GSTtax rate later decreases or stays the same andthe exemption increases or stays the same,your GST tax will probably be no worse than ifyou hadn't made the GST in 2012.In each of these scenarios, it has beenassumed that values do not appreciate. If theproperty transferred by gift increases in valueafter the gift, there may also be transfer taxsavings from removing the appreciation fromthe transfer tax system.You'll want to consider how these guidelines forlarge gifts in 2012 might apply to your specificcircumstances. An estate planning professionalcan help you evaluate them.
Other gift considerations 
While it might seem obvious,gifts should only be made if you can afford to part with the property.In general, it is usually preferable to make as many gifts as possible using the annual exclusion and the qualified transfers exclusion for medical and educational expenses before making taxable gifts that use up the gift and estate tax exemption. Annual exclusion and qualified transfer exclusion gifts do not use up the gift and estate tax exemption.When you make a gift of property, your income tax basis in the property (generally, what you paid for the property, with some up and down adjustments) is generally carried over to the person who receives the gift.When you transfer property at your death, the basis of the property is usually "stepped up" (or "stepped down") to fair market value at the time of your death.
Page 2 of 4, see disclaimer on final page
Withdrawals from Traditional IRAs
In these challenging economic times, you maybe considering taking a withdrawal from yourtraditional IRA. While you're allowed towithdraw funds from your IRAs at any time, forany reason, the question is, should you?
Why you should think twice
Financial professionals generally recommendusing your retirement funds for one purposeonly--retirement. Why? Because frequent dipsinto your retirement funds will reduce yourultimate nest egg. Plus, there will be lessmoney available to take advantage of the twinbenefits of tax deferral and any compoundearnings. Depleting your retirement funds toosoon can create a dire situation in your lateryears.And then there are taxes. If you've made onlydeductible contributions to your traditional IRA,then all the funds in your account are subject tofederal income tax when you withdraw them.They may also be subject to state income tax. Ifyou've made any nondeductible (after-tax)contributions to your IRA, then each withdrawalyou make will consist of a pro-rata mix oftaxable (your deductible contributions and anyearnings in your account) and nontaxable (yournondeductible contributions) dollars.All your traditional IRAs (including SEPs andSIMPLE IRAs) are treated as a single IRAwhen you calculate the taxable portion of awithdrawal. So you can't just transfer all yournondeductible contributions into a separateIRA, and then withdraw those funds tax free.And, if you're not yet age 59½, the taxableportion of your withdrawal may be subject to a10% federal early distribution tax (your statemay also apply a penalty tax).
10% early distribution penalty
To discourage early withdrawals from IRAs,federal law imposes a 10% tax on taxabledistributions from IRAs prior to age 59½. Not alldistributions before age 59½ are subject to thispenalty, however. Here are the most importantexceptions:Distributions due to a qualifying disabilityDistributions to your beneficiary after yourdeathDistributions up to the amount of yourtax-deductible medical expensesQualified reservist distributionsDistributions to pay first-time homebuyerexpenses (up to $10,000 lifetime)Distributions to pay qualified higher educationexpensesCertain distributions while you'reunemployed, up to the amount you paid forhealth insurance premiumsAmounts levied by the IRSDistributions that qualify as a series ofsubstantially equal periodic payments(SEPPs)
The SEPP exception to the earlydistribution penalty
The SEPP exception allows you to withdrawfunds from your IRA for any reason, whileavoiding the 10% penalty tax. But the rules arecomplex, and this option is not for everyone.SEPPs are amounts you withdraw from yourIRA over your lifetime (or life expectancy) or the joint lives (or joint life expectancy) of you andyour beneficiary. You can take advantage of theSEPP exception at any age.To avoid the 10% penalty, you must calculateyour lifetime payments using one of threeIRS-approved distribution methods and take atleast one distribution annually. If you have morethan one IRA, you can take SEPPs from justone of your IRAs or you can aggregate two ormore of your IRAs and calculate the SEPPsfrom the total balance. You can also usetax-free rollovers to ensure that the IRA(s) thatwill be the source of your periodic paymentscontain the exact amount necessary togenerate the payment amount you want basedon the IRS formulas.Even though SEPPs are initially determinedbased on lifetime payments, you canchange--or even stop--the payments after fiveyears, or after you reach age 59½, whichever islater. For example, you could start takingSEPPs from your IRA at age 50, withoutpenalty, and then, if you no longer need thefunds, reduce the payments (or stop themaltogether) once you reach age 59½.
Short-term loan
If you only need funds for a short period of timeyou may be able to give yourself a short-termloan by withdrawing funds from your IRA, andthen rolling those dollars back into the same ora different IRA within 60 days. However, watchthe deadline carefully, because if you miss it,your short-term loan will instead be treated as ataxable distribution. And keep in mind that youcan only make one rollover from a particularIRA to any other IRA in any 12-month period. Aviolation of this rule can also have seriousadverse tax consequences.
In these challenging economic times, you may be considering taking a withdrawal from your traditional IRA. While you're allowed to withdraw funds from your IRAs at any time,for any reason, the question is, should you? 
Page 3 of 4, see disclaimer on final page

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