Probate & Trust Law Section Conference Manual ... - Minnesota CLE

investment income to the transferee even though it was not (and is not) net investment income
to the transferor. In such a case, it may be more advantageous for the transferor to assign the
stock to a grantor trust, as the trust’s share of the S corporation would be imputed back to the
grantor and thus avoid imposition of the net investment income tax.
In the case of an estate or trust, the tax is 3.8% of the undistributed net investment
income or, if less, 3.8% of the amount by which adjusted gross income exceeds the dollar
amount at which the 39.6% bracket begins (that’s $11,950 in 2013). A trust’s exposure to the
net investment income tax may be mitigated by a number of techniques. First, the trustee can,
pursuant to regulatory authority under §652, allocate indirect expenses of the trust (those not
directly attributable to an income item giving rise to the expense) entirely to undistributed
ordinary income items of net investment income (which would otherwise be taxed at 43.4%),
before allocating such expenses to other forms of ordinary income, then to capital gains and
dividends. Second, trust agreements can be amended to authorize distributions of capital gains
that would otherwise be subject to the net investment income tax. Alternatively, independent
trustees may be given the discretion to consider the income tax consequences of distributions
in determining whether to make a distribution.
4. Planning for the Affluent
In addition to the net investment income tax, affluent taxpayers have to grapple with
the return of the overall limitation on itemized deductions. The §68 limitation on itemized
deductions was set to return in full force (i.e., with a threshold amount slightly over $175,000
of adjusted gross income). Under ATRA, it indeed returns, though with higher thresholds. Now,
the overall limitation on itemized deductions applies to joint filers with adjusted gross incomes
over $300,000, to unmarried filers with adjusted gross incomes over $250,000, and to heads of
household with adjusted gross incomes over $275,000. These amounts will be adjusted for
inflation in future years.
Under §68, otherwise allowable itemized deductions are reduced by either: (1) 80% of
the total itemized deductions otherwise allowable, or (2) three percent of the amount by which
the taxpayer’s adjusted gross income exceeds the applicable threshold from the prior
paragraph, whichever is less. Ultimately, then, a taxpayer subject to §68 could lose as much as
80% of the taxpayer’s otherwise allowable itemized deductions, effectively increasing the tax
rate otherwise applicable to the corresponding income.
It is likely that few clients will invest much interest in aggressive planning just to avoid
the application of §68. After all, every $10,000 reduction in adjusted gross income saves just
$300 in federal income tax. Instead of targeted planning for the overall limitation on itemized
deductions, the best planning here may involve simply educating the client that the effective
marginal rate applicable to income above the applicable threshold is an additional three
percent.
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