As Published in the Shore 2013 Edition of NJ Lifestyle
We are currently in a near zero interest rate environment and the Federal Reserve seems intent on keeping rates right there for the foreseeable future. This has caused investors to diversify the income portion of their investment portfolios and re-think ways to generate income outside of traditional savings and interest bearing accounts. Accordingly, investors have been bidding up dividend paying stocks. high yield bonds, MLP’s and real estate investment trusts, in part to replace the lost income that in the past had been previously so highly predictable and easily obtainable. Now the Federal Government wants its share too. Let us explain.

As a consequence of the Affordable Health Care Act of 2010, Congress passed a 3.8% tax on net investment income. This tax applies to long and short-term capital gains, dividends, taxable interest, rental income, royalties, and taxable income from investment annuities, REIT’s and MLP”s. Also, the subsequent sale of any investment property and even your personal residence may be subject to this tax (less exclusion). As has been the case for most new taxes recently, this tax will be borne by so-called “high income earners”, single filers with adjusted gross income of more than $200,000. Many investors are not even aware of this additional tax.
However a little planning now will save dollars later. Here are a few things we are advising our clients:
If you own a small business, consider establishing, contributing, and even maximizing your deferral and contribution to a qualified retirement plan rather than just taking a large bonus at year end. Putting a large portion of your investments in a qualified plan will shelter investments from this tax. In addition, when you eventually take distributions from these accounts, the pension or RA distribution income will not be subject to this tax.
If you are close to the income thresholds and are in a solid financial position, delay taking social security benefits. By waiting you will also be increasing your annual benefit. Likewise, if you are already withdrawing on your IRA accounts, consider a gift to your favorite charity directly from the retirement account, That IRA distribution will now bypass page 1 of your income tax return.
If you have a large capital gain in your portfolio and your other income is under the AGI limits, realize some of the gain in 2013 and take the rest in early 2014. Additionally, be sure you “harvest losses” (sell any losers) to offset realized gains within each year.
Consider underweighting investments that may pay interest, dividend, or royalties in your non-qualified (“taxable”) accounts and overweight those investments whose return is mainly appreciation. An example of this would be a small or mid-cap mutual fund or ETF or stock, such as Google. You may also purchase some investments that are not subject to this tax, such as municipal bonds, in your “taxable” accounts. Conversely, overweight your retirement accounts with income producing investments as tax deferred accounts are not subject to this additional tax.
Finally, especially in cases when you may not have a taxable estate, it may be best to do nothing and leave the decisions to your heirs. After all, they will not only receive a stepped up basis, but will also avoid the 3.8% investment tax on the subsequent disposition.
Similar to the need for your smart phone to interface with your desktop computer, investors need to “sync” their personal tax file with their investment portfolio or they may wind up paying more to Uncle sam in April 2014.