Rappelling Down the Fiscal Cliff – Strategies for Cushioning the Fall – Part I

by Gerald Nowotny

  1. Overview

Ready, set, go! Following the Presidential election last night, the race is on for year-end tax planning and bracing for the fall off the fiscal cliff.

While no one can tell exactly what the tax outcome will be after the election, we have a much better idea than we had before last night.  The Bush tax cuts are due to expire at the end of 2012. The President is on the record stating that he will oppose an extension of the Bush tax cuts for taxpayers earnings over $250,000 per year.

He also stated that he would favor an estate tax exemption of $3.5 million per taxpayer. Nevertheless, we still have a bipartisan Congress that can’t agree on anything including the date of the annual Congressional Picnic. However, the President holds the ‘Trump Card”, veto power.

This article is designed to outline a few tax planning ideas in light of the election. Part I focuses on some general tax planning ideas for corporate executives or salaried professionals.

  1. How Far is the Fall of the Cliff?

The answer depends on whether you fall from the top (highest income earner) or somewhere in between.

For joint filers, the threshold for the top marginal bracket of 39.6 percent is $388,350. If you live in high income tax states such as California, New York or Massachusetts can add an additional 6-10 percent

            State                                Top Tax Bracket          Income Threshold

            California                              10..3%                        $2 million

            Massachusetts                     5.3%                           Any level

            New York                              8.97%                         $500,000

The implementation of ObamaCare adds another 3.8 percent of taxation on unearned income for joint filers with taxpayers with adjusted gross income (AGI) in excess of $250,000. Top bracket income earners are also exposed to the phase out of personal exemptions and itemized deductions.

The phase outs have the effect of adding an additional two percent to the marginal bracket. The total effect is to give the New Yorker or Californian a top bracket of 53-55 percent.

The long term capital gains rate increases to 20 percent. Dividends will return to being taxed as ordinary income once again.

At the same time, the estate and gift tax exemption equivalent drops from $5.125 million to $1 million per taxpayer. As Congress can’t agree on anything, it seems unlikely that any last minute change will take place.

Are you listening yet?

     C. Corporate Jocks 

Corporate executives generally don’t have much to work with when it comes to personal tax planning. Generally, it makes sense to defer income if the taxpayer believes that he(or she) will be in a lower tax  bracket in the future.  The question is can future tax rates be even higher than current rates?

  1. Qualified Retirement  Plan Participation
  1. Max out deferrals in your 401(k) or 403(b) plans
  2. Make a deductible IRA contribution if you are eligible.
  1. Non-Qualified Deferred Compensation Planning – Defer salary and bonus income into a non-qualified retirement plan. If your company does not have one and you are in a position of influence within the company, recommend a plan.
  1. Reduce taxation on investment income – Do not forego prudent  asset allocation in favor of an investment  strategy of tax-free bonds. Use  tax structures for asset classes that are not tax efficient.
  1. Variable Annuities – Many products feature every fund objective under the Sun along with a large selection of managers. The guarantees in the product are expensive and are sinking the life insurers that can’t afford them but the guaranteed rates are compelling.
  1. Index and Sector Funds and Exchange traded funds
  1. Oil and Gas Limited Partnerships – Direct participation in an oil and gas investment partnership can create attractive write-offs. A typical  drilling program features a 2:1 or  3:1 deduction in Year 1.
  1. Roth IRA – If you are eligible.
  1. Super Roth IRA
  1. Charitable Program

This past elections did a good job of portraying the federal government as a public charity. If you follow that line of thinking you can pay taxes and allow the federal government to determine who the ultimate donee should be or you can create a long-term charitable contribution strategy of your own in order to select the ultimate charitable done as well as accomplish or tax management benefits  and retirement planning benefits.

  1. Charitable Gift Annuity – Make a cash or in kind contribution to a public charity and receive a partial tax deduction as well as an annuity which can be deferred into the future. The financial risk of the charity’s ability to make the payment can be reinsured with a commercial annuity.
  1. Charitable LLC – Create a family limited liability company or limited partnership. Capitalize the LLC with cash and marketable securities.

Contribute all of the non-voting interests (99%) to a charity (Army Powerlifting) or your donor advised fund which is a form of public foundation. Take a deduction up to 50 percent of your adjusted gross income (AGI). Carry excess deductions forward five years. Retain management and control over the LLC, while 99 percent of the LLC assets grow tax-free outside of you taxable estate.

The Charitable LLC allows you to retain a management fee which you can also defer into the future. Distribute funds from the LLC for the charities each year at your discretion as managing member of the LLC. You can also perpetuate this arrangement for multiple generations.

  1. Charitable Lead Annuity Trust (CLAT)

The current low interest environment is very favorable to charitable lead annuity trusts. The IRC Sec 7520 rate which is used to determine the deduction is now around one percent.

If you are fortunate to have a big year at work with a large bonus, exercise non-qualified stock options, or have restricted stock that vests, the CLAT is a way to get an upfront  deduction up to 30 percent of AGI, manage the money in the trust, while a charity receives the benefit of the income in this charitable trust for a period of time.

Eventually, the money reverts back to you at retirement or to a family trust. While the interest rate environment remains favorable, you can set up a new CLAT each year. Additional planning is available to defer taxation on the investment income within the CLAT.

  1. Charitable Remainder Trust (Net Income with Make-up Provision) - CRUT

At some point interest rates will increase due to deficit spending and inflationary pressure. The CRUT is the inverse of the CLAT. In the CRUT, the taxpayer receives an income for a term of years or life contingency and the charity receives the remainder interest after the income interest terminate.

It also uses the IRC Sec 7520 rate to determine the amount on deduction. Additional planning allows for the deferral of income payments until such time that you want to start receiving an income. Think of this as a partially deductible pension plan with charitable benefits.

  1. Start a Business

In Corporate American these days, it is a matter of time before you get downsized. With our stellar economy, it takes a long time to get a new job. In the interim, it may be a good idea to start that consulting company before you lose your job.

Additionally, the creation of a family investment business company is a legitimate business for state corporate law and federal tax purposes.

In the meantime, the creation of a business provides a legal basis for many tax deductions as reasonable and ordinary business expenses.

Here is a brief outline of some of those deductions: To

  1. Home Office Deduction
  2. Health Insurance
  3. IRC Sec 179 Deduction – Expense certain capital expenditures instead of amortizing them.
  4. Group Life Insurance
  5. Long Term Care Insurance
  6. Family Pension Plan

If you are fortunate to have a lot of taxable investment income that you don’t need to live on right now, you might consider creating a family pension plan.

Create a new business, i.e. a new LLC, to manage your family’s investment portfolio. You can reduce the taxable investment income by making tax deductible contributions into a retirement plan that will enjoy tax deferral until you withdraw the money.


You can take a “wait and see “posture  but given  the results of the recent election, the “wait” in “wand and see” has been eliminated. The future tax landscape looks pretty stark. Tax reduction and deferral strategies are available. In some cases, you need to be a little creative. Desperate times call for desperate measures within the tax law.





DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Gerald Nowotny, Law Office of Gerald R. Nowotny | Attorney Advertising

Written by:

Gerald Nowotny

Law Office of Gerald R. Nowotny on:

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