Congress to Increase Taxes on Individuals

With the passage of the new Patient Protection and Affordable Care Act, starting in 2013 the new law provides for 3.8% tax on “Net Investment Income” to help pay for nearly $1 Trillion in spending under the health care legislation. This has now been labeled the“Medicare Tax”.

For individuals, this 3.8% additional tax is imposed on the lesser of:
(i) Net Investment Income; or,
(ii) Modified adjusted gross income exceeding $250,000 for married couples filing jointly or $200,000 for single tax payers.

This 3.8% tax increase also implies to Net Investment Income of trusts.

Net Investment Income encompasses interest, dividends, capital gains (other than income from an active trader business not primarily engaged in investment trading activity), rent and royalties as reduced for applicable specific deductions.

It appears that tax exempt interest from municipal bonds and similar investments will not be subject to this tax. Also exempt are distributions from IRAs and qualified retirements plans such as 401(k) and profit sharing plans.

With the ending of the Bush tax cuts which are scheduled to expire at the end of 2010 long term capital gains rates will increase next year from 15% to 20% and dividend rates will again be taxed as ordinary income starting next year. With the corresponding expiration of the cuts in ordinary income tax rates, the top rate on dividends will be 39.6% (federal). This will be a resumption of the Clinton-era top income tax rate.

In addition, starting in 2013 the new law increases the 1.45% Medicare portion of FICA taxes by .9% on wages exceeding $250,000 for married couples jointly or $200,000 for single taxpayers. Also, starting in 2013 (and in 2017 for individuals and their spouses age 65 or older) the floor for deducting medical expenses will increase from 7.5% to 10% of adjusted gross income.

However, twenty (20) states have now filed suit to overturn the new law on constitutional grounds. Where this will end up is anyone’s guess at this point? Very few such constitutional challenges are successful. What is apparent is that the trend of current tax law will create significant increases in many individual’s personal income taxes at almost all levels. The need for efficient tax planning is now even more necessary for the preservation of one’s wealth.

Community Spouse Owned Annuities are no longer available resources for Medicaid Purposes

In a decision on April 20, 2010 out of the Western District of the Missouri Court of Appeals, the appellate court reversed the trial court and barred the Missouri State Family Support Division from counting a community spouse's ownership of a commercial annuity as an "available resource" to disqualify an institutionalized spouse from Medicaid assistance. The court found that treating a community spouse's income stream from a commercial annuity as an available resource which denied coverage for the institutionalized spouse for Medicaid assistance was a violation of federal Medicaid law.

Creditor Protection Benefit of the Stand Alone IRA Beneficiary Trust

In a recent bankruptcy court decision out of the Eastern District of Texas (In re: Chilton) the court found that an inherited IRA is not the equivalent to an IRA for purposes of determining whether the account contains “retirement funds” that may be exempted from the bankruptcy estate under U.S.C. §522(d)(12).

Courts have listed several reasons for distinguishing an inherited IRA from an IRA which allows the creditors to reach the inherited IRA assets:

• The state exemption was for retirement benefits to be available to the retired person, not a child who was still earning a living;
  
• The beneficiary of an inherited IRA has an unrestricted right to withdrawal of the IRA at any time without any penalties;
  
• And, the IRA is significantly different than an inherited IRA under the Internal Revenue Code.

The Chilton case highlights the dangers of relying on the bankruptcy code to provide protection for an inherited retirement accounts. To obtain solid asset protection we recommend that retirement plans be payable to a Stand Alone IRA Beneficiary Trust that is drafted to qualify as a designated beneficiary under Internal Revenue Code Section 401(a)(9) and that contains spendthrift language. The incremental cost of creating a Stand Alone IRA beneficiary trust is more than offset by the benefit of protecting the inherited IRA assets during the lifetime of the beneficiary from creditors, predators and spouses.