All of the hope and promise of spring is nearly upon us, and with young shoots beginning to peek from the ground and the scent of loam and a hint of wildflowers in the air, it's easy to forget the dead leaves of last year's winter skittering across lonely roads. Still, it's this time of year that most people inevitably look to their CPAs, investment advisers, financial planners and bookkeepers to help them sum up the previous year in tax terms.
With taxes already on the brain, let's cover a few forward-thinking tax strategies that take into account new tax legislation for 2013, with an eye to investments and financial planning. The list of tax planning strategies is long and varied, so consider this list ultimately incomplete but helpful nonetheless.
This one's for your health
One of the newest taxes to be levied on "net investment income" comes to us as an uninvited houseguest — unpopular, unwelcome and unlikely to leave any time soon. As most investment advisers and CPAs likely know, the Patient Protection and Affordable Care Act, aka Obamacare, should not be ignored, because exposure to the new Medicare surtax can be minimized in some cases.
The 3.8 percent tax has gone into effect this year on "net investment income" for folks with modified adjusted gross income (the same as adjusted gross income for those without foreign earned income) above $125,000 for married couples filing separately, $200,000 for individual filers, and $250,000 for a married couple filing jointly. It stands to reason that if you can keep your MAGI below those levels, you can more effectively avoid the new tax, but for those well above those thresholds, you should prepare to pay your share of this tax.
Divisive dividends and interest
Add this new Medicare tax to the newly defined dividend tax rates and you could incur taxation to the tune of 23.6 percent on dividends earned this year as opposed to the maximum 15 percent rate on those same dividends earned this time last year. In other terms, you may be looking at a tax hike of 8.6 percent.
While many investors in the past have looked to municipal in order to avoid taxation on the interest income, as it is not included in "net investment income," quite a few investors have concerns about the solvency of some municipalities and thus the viability of the securities they issue. Add to this the fact that many municipal securities may have been overbought, thus pushing down yields to untenable rates, and one may wonder where the true value in municipal bonds lies.
Simply put, the value in a municipal bond is its tax-benefited status. For taxpayers in the highest tax bracket, a 3 percent tax-exempt bond will earn the equivalent after-tax return of a taxable bond earning 5.3 percent. I don't know about you, but a 2.3 percent difference in yield is worth a little more attention — now good luck finding that security in this environment while incurring only reasonable risk of insolvency.
How to participate… materially
If you are part owner in an S corporation or a partnership, you may have a little more wiggle room to avoid this new surtax on net investment income.
Among other things, net investment income includes income from "passive activities," so if income from your share of the business represents passive income, you may want to take a long hard look at how to get a little more active in the business. According to tax law, this would mean participating materially in the business so as to eliminate the "passive" element of that income, thus avoiding classifying the income as net investment income and avoiding incurring the 3.8 percent tax.
There are seven tests to material participation, and by meeting just one of them you can count your participation in the business as material, many of which speak to the amount of time you spend working on said business.
For instance, if you find yourself spending less than 500 hours a year working on an S corp or partnership, then tossing in a few more hours to support that business could mean the difference between shelling out an additional 3.6 percent in taxes this year or saving it toward your retirement.
Anthony M. Conte is managing partner at Conte Wealth Advisors LLC in Camp Hill. Contact him at firstname.lastname@example.org.
Registered Representative Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Cambridge and Conte Wealth Advisors, LLC are not affiliated.