Tax planning for the 3.8 percent Medicare surtax

Time may be running out for trustees to act

The US tax environment—by its nature a constantly developing landscape—was again modified with the enactment of the American Taxpayer Relief Act of 2012 (ATRA). Among the legislation’s many revisions are adjustments that significantly impact the income taxation of trusts and estates.

Fortunately, the post-ATRA world continues to include a number of opportunities to realize tax efficiencies via proper planning. However, time may be running out for trustees of certain trusts to avoid adverse tax consequences for the 2013 tax year.

Under current tax rules, individuals and trusts and estates are subject to the same set of income tax rate percentages, but the income ranges (or tax brackets) within which the tax rates are applied differ significantly between the two types of taxpayers. Beginning Jan. 1, 2013, the income of non-grantor trusts in excess of $11,950 is generally subject to a federal tax rate of 39.6 percent. In contrast, for many single taxpayers, only taxable income in excess of $400,000 is subject to the top rate of 39.6 percent. Further, the net long-term capital gains (and qualified dividends) of trusts are subject to tax at an increased 20 percent rate at the same $11,950 threshold.

In addition, and as if the increased regular and capital gains tax rates post-ATRA are not, by themselves, a disincentive to the buildup of trust value, the introduction of a new 3.8 percent “net investment income” tax also applies to trusts. Specifically, for estates and trusts, a 3.8 percent tax is imposed (in addition to the traditional income taxes) on certain taxable, undistributed income in excess of that $11,950 threshold. Conversely, many single taxpayers only will pay this additional tax on a certain portion of their unearned income where their adjusted gross income (AGI) exceeds $200,000 (or $250,000 for married taxpayers filing a joint return).

Given this new 3.8 percent surtax and the compressed tax brackets that are applied to trusts, annual distribution planning by trustees will be of great importance. Indeed, a key to making efficient use of trust distributions is to identify situations where the distributions will carry out the proper types and amounts of income to individual beneficiaries in lower tax brackets. With a 39.6 percent top marginal tax rate, a 20 percent top long-term capital gains rate, and the additional 3.8 percent surtax on net investment income, the trustees of trusts will have to give some additional thought to whether amounts should be distributed from non-grantor trusts in the coming years. As part of these planning decisions, keep in mind that distributions made from certain trusts within the first 65 days after year-end can, with the use of a specific election, be treated as distributions made during the prior taxable year. As a result, the election allows a trustee to review the complete picture of annual trust income and make appropriate distributions shortly after year-end to take advantage of any variance between individual and fiduciary income tax brackets.

Perhaps the most important takeaway here is the growing need for individuals with trust relationships (whether existing or anticipated) to fully consider the tax implications of their decisions. The new 3.8 percent surtax may or may not be something that triggers change in trust administration, and consideration should always be given to the non-tax motives and desires of the trust creator as articulated in the trust document’s directives and powers. It is best to work with a tax professional well versed in fiduciary accounting and taxation who can help clients plan to realize the most efficient trust administration from tax and non-tax perspectives.                                                                    

For more information on this topic, or to learn how Baker Tilly tax specialists can help, contact our team.


The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.