Attention All Cadets (and Midshipmen)! – Tax Planning Battle Plan for 2012 and Beyond

I  Overview 

In case you have been in the trenches or out at Sea since the beginning of the year, here is what the tax landscape looks like going forward into 2013. The Bush tax cuts are due to expire at the end of 2012 absent tax reform in a presidential election year and a “lame duck” Congress, following the election in November. The consequences of the expiration of the Bush tax cuts are severe for taxpayers.

A. Income Tax

(1) The top marginal bracket increases to 39.6 percent.

(2) A  Medicare tax of 3.8 percent on unearned income for taxpayers with joint adjusted gross income (AGI) over $250,000 adds a little more salt to the wounds.

(3) The phase out of itemized deductions for personal exemptions and miscellaneous itemized deductions has the effect of adding another one-two percent to the marginal rate.

(4) If you live in a state like California, New Jersey, New York, And Massachusetts, you can add another 8-10 percent on top of the federal marginal tax bracket.

(5) The long-term capital gain rate increases to 20 percent. For the wealthy taxpayer that number becomes 23.8 percent after considering the new Medicare tax. Additionally, most states treat capital gain income as ordinary income. The net result is a long term capital gains rate that could be 30 percent or more.

(6) The tax rate on dividends goes from 15 percent to as high as 43 percent.

B. Estate Tax

(1) The exemption equivalent, i.e. how much can you own and transfer before it is subject to federal gift and estate taxes, drops from $5.125 million per taxpayer to $1 million.

(2) The top marginal estate tax bracket increases from 35 percent to 55 percent.

C. Asset Protection

(1) If you are living anywhere in the USA, and you have any degree of success, you have a target on your back for being sued.

Are you confident that you won’t be sued, and if you are sued, do you think that the legal system will treat you fairly?

(2) Asset protection exemptions in virtually every state are worthless if you have any degree of success.

(3) Take a look at your personal umbrella policy and commercial general liability exclusions to see everything that it does not cover.

This executive summary is designed to highlight a few key considerations for the second half of the year as we quickly approach a major tax change.

II   Planning Considerations

Who knows what the future tax landscape looks like except for the basic notion that tax rates will be higher.  A few thoughts on income tax deferral and reduction:

 1. W2 Income Earners

You don’t have much to work with here except increasing itemized deductions. Absent starting a business, consider increasing your charitable deductions with the following strategies.

a. Charitable LLC

Create a Delaware or Nevada Limited Liability Company (LLC). Capitalize the LLC with cash and marketable securities or other property. You can also fund the LLC with your non-qualified stock options and possibly your restricted stock.

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.

b. Charitable Lead Annuity Trust (CLAT)

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.

c. Start a Business

In this day in age in Corporate America, it is a matter of time before you get downsized. Start that consulting business now before it happens. 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:

(1) Home Office Deduction

(2) Health Insurance

(3) Pension Plan

(4) IRC Sec 179 Deduction – Expense certain capital expenditures instead of amortizing them.

(5) Group Term Life Insurance

(6) Long Term Care Insurance

d. 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.

e. Life Settlement Contracts

Life insurance policies can be purchased as an investment in the secondary market at a large discount. These policies are usually issued by investment grade life insurers on seniors who have a life expectancy of 4-8 years.

In the current market, policies can be purchased at 5-10 percent of the face amount (death benefit) of the policy. A third party valuation firm may also value the same policy at 25-30 percent of the face amount. If you use a LLC as the investment entity for the purchase of the life settlement contracts, and contribute LLC interests to a public charity for a deduction up to 50 percent of your AGI.

2.    Business Owner 

a.      Make an Election to be taxed as a C Corporation 

Over the last 10-15 years, virtually every new business has been created as a pass-through entity such as a LLC or S Corporation. As a result, businesses have been taxed at the individual shareholder’s  tax rate. With tax rates increasing in the near future, it may be time to rethink that strategy and create a new subsidiary of the company that is a regular corporation, i.e. C Corporation.

The tax arbitrage may be more favorable for a business owner in New York or California that may be taxed at a combined rate of 55 percent while the corporate tax rate on the first $50,000 is 15 percent. At the same time, a number of tax planning strategies exist to minimize corporate taxation.

b. Defer Taxation on International Sales

If you do some business internationally, consider creating a foreign corporation to defer U.S. taxation while also avoiding taxation abroad. In order to accomplish this result, you need to navigate carefully through the tax minefield to avoid Controlled Foreign Corporation (CFC) treatment.


You may be able to achieve substantial tax reduction and deferral for your business overseas  by creating an Interest Charge Domestic international Sales Companies (IC-DISC).  This works for exporters as well as engineering and architectural firms.  An Interest Charge Domestic International Sales Corporation ( IC-DISC) is a tax-exempt, domestic corporation set up to receive commissions on your company’s international sales.

The IC-DISC does not need to have an office, employees or tangible assets nor is it required to perform any services. The attractiveness of the IC-DISC is its ability to defer international taxation at a relatively low cost, the interest charge against any deferred income. The interest charge is based upon the yield on treasury bills.

d. Captive Insurance Company

A captive insurance company is a closely held insurance company designed to insure the under-insured and uninsured property and casualty risks of your operating companies. The captive insurance company is owned by the business owner or a family trust for estate planning purposes. The business owner retains management control over the investment of the captive’s assets.

The business owner as the majority shareholder, CEO and Chairman of the board of directors, has full control over the management of the captive. From an income tax perspective, the premiums are a tax deductible expense to the operating company (the insured) and the captive insurance company pays little or no taxes.

From a gift tax perspective, the premiums paid by the company are not treated as a taxable gift to the family members who may be beneficiaries of a family trust owning the captive insurer. The exit strategy for a captive may be a sale or liquidation at long-term capital gains rates.

 3.   Estate Planning

The exemption equivalent reduces form $5.125 million to $1 million per taxpayer at the end of this year. This means a taxpayer and his spouse can gift $10.25 million in 2012 without the imposition of gift taxes. A family trust arrangement can be structured that would allow the taxpayer and the spouse to remain income beneficiaries for the balance of their lifetimes if needed. This is a once in a lifetime opportunity.

4. Asset Protection

The only reasonable certainty of protecting your assets from the claims of creditors is offshore asset protection planning. Nevada and South Dakota are good interim measures but do not offer the legal certainty of the offshore jurisdictions. If the federal government is a potential creditor, offshore is your only chance. If you have a potentially contention divorce and property settlement in your future, offshore is your only chance to protect your assets.


You can take a “wait and see “ posture regarding tax reform but you will miss out on a few planning opportunities that are expiring. It would appear that tax increase is a likely certainty in one or another. I have briefly outlined a few sophisticated strategies to consider in your own tax planning.

Feel free to reach out to me to discuss any of them.

Beat Navy!

About gerrynowotny

I am a tax and estate planning attorney with a JD and LL.M in estate planning from the Univesity of Miami School of Law. I have worked in the life insurance industry for twenty three years and the last eleven in private placement life insurance.
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