Future Tax Rules Can Further Penalize LGBT Investors

But there is still time to act
by Grace S. Yung

Currently, unless Congress does something to avert what is referred to as “the fiscal cliff,” many upper-income U.S. households will be facing an average tax increase of nearly $3,500 in 2013. Those who are in the top one percent of income-earning households will be hit the hardest, with an average tax increase of $120,000.

Even middle-income-earning households are not left out of these tax hikes. For those who earn between approximately $40,000 and $60,000 per year, taxes will also increase to the tune of roughly $2,000 per year.

As 2013 approaches, income tax isn’t the only thing set to go up. Beginning next year, the tax rate on long-term capital gains—i.e., the gain on the sale of certain assets that have been held for longer than one year—will increase to 20 percent. (These gains will be taxed at a rate of 10 percent for those who are in the 15 percent income tax bracket.)

Added to this, capital gains income could also be subject to an additional Medicare tax of 3.8 percent for those taxpayers who have adjusted gross incomes of over $200,000 and file individually. This is a new tax on income that is received via investment dividends and interest, as well as from rental income, annuities, and royalties. It is similar to the combined employer and employee tax rate on one’s earned income.

Adding fuel to the fire, when selling one’s home, any amount of profit that exceeds the IRS exclusion will be classified as a capital gain. Therefore, even those who sell their primary residence in 2013 may be subject to this 3.8 percent “unearned” income tax on the gain that is obtained from such a sale (depending on the taxpayer’s annual adjusted income, as well as the sale amount that exceeds the IRS exclusion).

Dealing with Future Estate Taxes

In addition to income and capital gains taxes, individuals may still be liable for estate taxation—depending on the value of their overall estate at the time of death. Over the past several years, the estate tax, which is often referred to as the “death tax,” had been declining, and in 2010, it disappeared altogether—at least temporarily.

While the 2001 Bush tax cuts were extended under President Obama, as of January 1, 2013, the estate tax may go as high as 55 percent, and the exclusion amount will drop to only $1 million, down $4 million from where it currently stands.

This is not good news for business owners and wealthy individuals. And, for those in the LGBT community who already must plan around being excluded from tax breaks such as the unlimited marital deduction, this will likely mean being further penalized by Uncle Sam.

Defining the Transfer of Assets

There are many tax advantages that are available to legally married spouses that are not available to domestic partners. One of the most advantageous of these is the unlimited marital deduction. This provision allows one spouse to transfer an indefinite amount of assets tax-free to his or her spouse at any time, during life and/or at death.

The 1996 Defense of Marriage Act defines a married couple as being partners of the opposite sex. Therefore, unlike legally married heterosexual couples who may transfer an unlimited amount of assets tax-free to a spouse, those in the LGBT community must find alternate estate planning routes to help in reducing their estate tax obligations.

There Are Strategies

Many turn to life insurance policy death benefits in order to pay estate taxes. Yet, without proper planning, such benefits may also be actually included in a decedent’s estate, resulting in an even larger taxable amount.

However, the death benefits that are paid under life insurance policies that are owned by an irrevocable life insurance trust, or ILIT, may essentially be loaned to the insured’s estate in order to pay estate taxes, or they can also be used to purchase illiquid assets from the estate, thus providing cash for the payment of the estate taxes that are due.

In any case, one great benefit of using an ILIT for LGBT estate planning is that the liquidity goal can be accomplished without the need to include the insurance proceeds in the estate value calculation of the insured.

In addition, the surviving domestic partner may also be made an income beneficiary of the ILIT. In this case, as long as the surviving partner is just an income beneficiary of the trust, the assets that remain in the trust will not be included in the surviving partner’s estate at their death.

When it comes to the avoidance of the additional capital gains tax that investors may be subject to, it could make sense to sell those assets that have a significant amount of gain before December 31, 2012. In some cases, this could end up saving investors a great deal in additional tax liability, resulting in a larger overall net.

The Bottom Line

While there is still time remaining in 2012, some in the LGBT community may benefit from booking investment losses prior to December 31 in order to offset potential gains going forward. Likewise, those investors with gains now may want to consider taking those during 2012, while they may still do so at a lower tax rate.

All situations will call for an overall plan that uniquely fits with an individual’s or couple’s specific goals. Therefore, in order to best prepare for your financial needs, all planning should be done through a qualified professional who is well-versed in these types of issues. To help ensure the outcome that you desire, it is best to have an accountant or CPA, as well as your financial professional, working together to pursue the very best results.

Grace S. Yung, CFP, is a certified financial planner practitioner with over 18 years of experience in helping domestic partners to plan their finances. She is a principal at Midtown Financial LLC in Houston.

See other MoneySmart columns:

Protecting your Wallet and your Heart (October 2012 OutSmart)
How and when to keep assets separate—even when you’re madly in love

Domestic Partner Tax Deductions in Home Ownership (September 2012 OutSmart)
With today’s historically low interest rates, it’s certainly a great time to either purchase or refinance a home.

Dying Intestate (August 2012 OutSmart)
Could you be leaving the state in charge of distributing your assets?

Protecting the Things that Matter (July 2012  OutSmart)
How those in the LGBT community can use life insurance planning strategies

When ‘I Do’ Becomes ‘I Don’t Anymore’ (June 2012 OutSmart) 
Ensuring both partners’ fair share with a Domestic Partnership Agreement

Retirement (May 2012 OutSmart)
Using annuities can provide lasting income for both domestic partners: When depending on a partner’s retirement income, annuities can offer the perfect solution

Financial and Tax Planning Issues for Domestic Partners (April 2012 OutSmart)
Is Uncle Sam getting a bigger chunk of your income and wealth?

The Real Cost of Long-term Care (February 2012 OutSmart)
How LGBT caregivers are paying the price

Gay Money Matters (part 1)(February 2010 OutSmart)
Domestic Partners: Estate and Tax Planning

Gay Money Matters (part 2)(February 2010 OutSmart)
Protecting your assets . . . even when the rules don’t


Grace S. Yung

Grace S. Yung, CFP, is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial LLC in Houston and was recognized as a “Five-Star Wealth Manager” in the September 2017 issue of Texas Monthly.

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