Yes, you read that right. There was a 58.7% increase in tax rates on taxes paid by certain taxpayers as of the beginning of 2013.
That’s the increase in capital gains taxes for folks in the highest ordinary tax brackets, due to the increase in the capital gains rate from 15% to 20%, and the additional 3.8% Medicare tax that was part of the Affordable Care (“Obamacare”) Act.
And that’s ignoring any potential state-level income taxes (California’s increased substantially in 2012, too).
But don’t worry, since that only affects the ultra-high-income, right?
No. It also kicks in at an income of a mere $11,950 for any income retained by a trust. Similarly, the highest ordinary income tax rate of 39.6% (plus 3.8% Medicare tax) kicks in at that same level.
But only “the rich” use such trusts, right? Wrong. Irrevocable trusts have been a staple of estate management for a very long time and there are plenty of irrevocable trusts which were funded back when the estate tax kicked in on much more modest estates than the current $5million level. As recently as the late ’90s, the estate tax kicked in at $600,000 (and at a 55% rate). Plenty of trusts funded in the ’90s are still around and are now paying these levels of taxes.
And many of these trusts hold securities which throw off capital gains distributions (as most mutual funds do) where the holder/trustee has no control over when or how much those distributions are, and often no ability to pass that taxable income to the beneficiaries who may have much lower tax rates, since capital gains are typically retained by these trusts.
Further, if the trust has a beneficiary in California, the state may be entitled to income taxes as well, even if the grantor and/or trustee, and/or other beneficiaries are not in California. California’s income tax may be as high as 12.3% on capital gains, for a combined Federal/State (even accounting for the Federal deduction on State income taxes) of over 33% on long-term capital gains. That’s a far cry from the 15% as which we may have expected those gains to be taxed.
If you are the beneficiary or trustee or grantor to any irrevocable trust, make sure you check in with your tax and investment advisors and understand how these new high levels of taxation may affect you. And you certainly don’t have to be one of the super-rich or ultra-high-income folks to be affected, since trusts pay taxes very differently from how individuals do.