Everyone’s talking about the new Net Investment Income (NII) Tax that applies to high-income individuals on dividends, interest income and capital gains. This new tax of 3.8% is in addition to increased income tax rates, the highest being 39.6%. This means that wealthy individuals pay a combined rate of 43.4% BEFORE adding state income taxes. If you are the executor of an estate or the trustee of a trust, you should know that these egregiously high rates apply to estates and trusts too, and not at the high income levels of individuals.
In 2013, for estates and trusts, the 39.6% income tax rate as well as the 3.8% NII tax kicks in at $11,950 of income. That’s not very high. And don’t forget, you don’t need $11,950 of investment income to pay the NII tax. If the total income exceeds the $11,950 threshold, the NII tax might be due on all of the investment income.
Let’s say an estate has income of $211,950. The tax on the $200,000 (income in excess of the $11,950 threshold), at 43.4% equals a tax of $86,800. Ouch!
Help! Is there any hope?
Yes, the estate and trust only pays tax on what’s not distributed. Distributions lower the income tax for the trust and at the same time increase the recipient’s personal income tax. However, individuals do not pay the highest rates unless they are wealthy. In our example, if there are four beneficiaries and each receive $50,000 (one-fourth of the $200,000) they may only pay 15% on that $50,000. That’s $7,500 per beneficiary for a total of $30,000 instead of $86,800 for a tax savings of $56,800.
It’s too late. I didn’t distribute anything in 2013.
It’s not too late. There’s a rule allowing distributions made in the first 65 days of the next year to be treated as made in the prior year. This year’s deadline is Mar 6, 2014. Executors and trustees have less than one month to consider this opportunity for substantial tax savings.