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Be Conscious of Taxes When You Invest

CG TaxesIt’s tax time again. While many high earners were aware that rate increases and new taxes went into effect for the 2013 tax year, the full impact won’t hit until they find out what their full tax liabilities are.

Here is a re-cap of the tax-rate changes:

The top federal marginal income tax rate for 2013 is 39.6%, up from 35% for 2012. This rate kicks in for all taxable income above $450,000 for a couple filing jointly, or $400,000 for a single filer (income below those amounts is taxed at lower rates).

The federal rate for long-term capital gains and dividends from stocks held for a year or more has increased from 15% to 20% for a single person with taxable income above $400,000 or a married couple with income above $450,000. People in a 25% or 35% tax bracket will continue to pay 15%, while those in a 10% or 15% bracket do not have to pay capital gains taxes.

The new Medicare surtax

The Medicare tax for 2013 income applies to high earners, people with investment income, and small business owners.

  • You’ll have to pay 0.9% more in Medicare taxes on earned income above $200,000 if you file as a single, or $250,000 if you’re married and file jointly.
  • At the same income levels, you’ll have to pay an additional Medicare tax of 3.8% on your investment income. Investment income includes interest, dividends, royalties, and passive-activity income (e.g., rental income, limited partnerships).
  • Small-business income classified as “income, gain or loss on working capital” is also subject to the Medicare surtax, which is not deductible through self-employment.

Safe harbor rates for higher-income taxpayers

If you’re in the top bracket and paid estimated taxes based on the safe-harbor rule of 110% of your previous year’s tax liability, you will have avoided penalties. However, even if your income is unchanged, you may be in for a unpleasant surprise when your taxes are calculated given the combination of higher rates and the Medicare surtax.

Changes for California residents

California residents already faced the highest marginal income tax rate in the country, and their long-term gains are treated as ordinary income for tax purposes. Things have gotten a bit worse for high earners for the 2013 tax year: A new mental health services tax of 1% will be assessed on all income above $1 million, regardless of filing status.

Ways to reduce the tax bite

You can’t do anything now about the taxes you owe for 2013, but you can take steps to reduce your tax liability for 2014. One thing to consider is a portfolio that focuses on tax-loss harvesting year-round—not just in the fall. Basically, you sell investments that have lost money and replace them with investments with a similar but not identical market exposure. The losses can be used to offset gains. Please see our earlier blog post that discusses tax-loss harvesting in greater detail.

Advisor Partners, which manages many of our clients’ assets, can construct diversified portfolios that actively harvest taxes to improve after-tax returns. Please let us know if you’d like to find out more about this strategy.

Make smart use of your IRA

To postpone realizing gains from investments that produce healthy dividends and/or are expected to appreciate significantly, keep them in an IRA account. Your tax rates upon retirement will likely be lower than they are now. And if you put these growth investments into a Roth IRA, you won’t owe taxes even when you begin withdrawals later on.

Small business owners have many options

There is a broad range of pension planning strategies that small business owners can take advantage of. We recently added a new page to our website about pension planning, and we encourage you to read about your options if you own a small business.

Focus on tax efficiency

It is important for investors in all tax brackets to remember that when any investment reports its gains, it’s usually in pre-tax dollars. But smart investors know the only performance that really counts is what their investments returned in after-tax dollars.

To learn more about tax efficient investing, please call or e-mail us today at (925) 365-1533 or

Accretive Wealth Management is not a tax firm or a certified public accountant and cannot offer tax advice. Please consult your tax advisor. If you don’t have one, we can recommend one to you.

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