Planning for the 3.8 percent surtax on Trusts and Estates

A new tax planning concern for fiduciaries is  the impact  the new 3.8% income tax surcharge will have on trusts and estates for taxable years beginning on and after January 1, 2013.  These new surcharges have been put into place to help finance the recent healthcare reform.

New section 1411 of the Internal Revenue Code imposes an annual 3.8 percent tax on the lesser of (a) the undistributed net investment income of a trust or estate or (b) the excess of adjusted gross income over the top inflation-adjusted bracket for estate and trust income, which is expected to be approximately $12,000 in 2013.

This surtax also will apply to the net investment income of individual taxpayers, including distributions of net investment income from trusts and estates.  The surtax will generally be paid by taxpayers on net investment income when the taxpayer’s modified adjusted gross income exceeds the established thresholds, which are $125,000 for married person filing separate, $200,000 for an individual or $250,000 for a married couple filing jointly.

For trusts where income distributions are discretionary (not required) the new surtax creates additional considerations for fiduciaries in deciding whether, when and to whom to distribute income.  The fiduciary will need to consider a beneficiary’s net investment income and if a distribution will push the beneficiary into the surtax brackets on their individual return.  If the trust or estate has less than $12,000 in net investment income annually, the surtax may be avoided by retaining the income inside of the trust.

Also in an estate where the decedent died in 2012, the personal representative should consider electing the first year tax year to end on November 30, 2012.  The second tax year would begin December 1, 2012, thus keeping the first two tax years from falling under the new surtax rules.

Timing distributions in estates will be crucial.  Fiduciaries  will want to pay particular attention to timing distributions, income and expenses to minimize the amount of the surtax.  Additionally, fiduciaries may want to consider investing in tax exempt securities, since the income from these investments is not subject to the surtax.

Even though the 3.8 percent health care surtax will not go into effect until 2013, taxpayers who will be exposed to it should begin planning now.  If you need assistance in planning for a trust, estate or individual taxpayer please contact our Estate Administration Division or Tax Division.

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