Your Most Important Tax Moves Before December 31

Alexander Green
by Alexander Green, Chief Investment Strategist

In his acceptance speech after his re-election, President Obama said he will make reducing the deficit a priority in his second term. During the long campaign, neither he nor Mitt Romney gave many details about how much they would cut from which programs. But Obama did make some very specific tax proposals.

In particular, he promised to:

  1. Raise the top marginal income tax rate to 39.6%.

  1. Raise the top short-term capital gains tax rate to 39.6%.

  1. Raise the top long-term capital gains tax rate from 15% to 20%.

  1. Raise the top tax on dividends from 15% to 39.6%. There will also be an additional 3.8% tax on dividends (to pay for “ObamaCare”) as of January 1.

  1. Replace the alternative minimum tax with the “Buffett Rule.” That means the highest income-earners will pay a minimum 30% tax rate on wages, interest, dividends and capital gains.

  1. Raise the estate tax rate from 35% to 45%.

Readers should take several important steps to minimize their tax bite before December 31.

Some Tips for Tax Managing Your Portfolio

The first rule is to max out your IRA and 401(k) contributions, which are made with pre-tax dollars.

If you reside in the upper tax brackets, make sure that municipal bonds make up a substantial part of your fixed-income portfolio. They yield more than Treasury bonds and interest paid is exempt from federal taxes. Be sure to own your home state’s bonds (or bond funds) if you live in a high-tax state.

Third, be sure to tax-manage your investments. This simply means running your portfolio with an eye to keeping the IRS off your back. Here are four ways to practice tax-efficient investing:

  1. Minimize turnover. Taking short-term capital gains means subjecting yourself to short-term capital gains taxes. So hold winners for at least a year, if possible. If you do, you’ll qualify for long-term capital gains treatment at the maximum rate of only 15%.

  1. Offset even these gains with capital losses. The IRS allows you to offset all of your realized capital gains with realized capital losses. And you can take up to $3,000 in additional losses against earned income.

  1. Defer taxes. Use your IRA, pension, 401(k), or other tax-deferred account to own corporate or U.S. government bonds (since interest income is taxed at the same rate as earned income) and real estate investment trusts (since REIT dividends are taxed that way, too).

  1. Use index funds rather than actively managed funds in your non-retirement accounts. Index funds are generally tax-efficient because changes to the indices are rare. Managed funds often have high turnover and Federal law requires them to distribute at least 98% of realized capital gains each year. You can get hit with a big capital gains distribution even when you haven’t sold a share and even if the fund is down for the year. That hurts on April 15.

Yet another tax break is to invest in fine art and give it to charity. The 1995 Tax Act allows you to donate works of art at their fair market value – not at their cost basis. (The IRS requires you to hold these items for one year in order to donate them at their assessed value.) And you don’t need a lot of money to get started.

Pillar One Advisor Mike Kuschmann, a former lecturer at the Stanford Business School and President of Fine Arts Limited, can help.

He offers clients the ability to acquire works of art at a deep discount to their published value, hold them a year and then donate them to the charity of their choice at fair market value. It can save you thousands of dollars. For more information, feel free to call him at 800.229.4322 or 407.702.6638. He’ll send you a complimentary brochure pack, detailing his services and the tax savings available.

The important thing is to recognize and take advantage of incentives in the tax code. The savings can be substantial.

Remember, it’s not how much you make. It’s how much you keep.

Good Investing,

Alex

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