THREE CAPITAL GAINS TAX PLANNING STRATEGIES

Jon T. Meyer, CFP® at BGM Wealth Management offers 3 capital gains tax planning strategies, let's take a look.  Jon writes: Retirement planning is both a little simpler and a little harder as a result of the fiscal cliff legislation. The American Taxpayer Relief Act (ATRA) of 2012 has changed the way many people should think about retirement income strategy. On one hand, things are simpler because the bill makes many of the new rules permanent. On the other hand, things got a little harder because there are so many vagaries that can trip you up. The capital gains/dividend tax is a good example.

Capital Gains and Dividend Taxes: The Basics

The ATRA changed tax rates on capital gains based on income level. For those with over $450,000 of taxable income (not modified adjusted gross income; taxable income is after your deductions) the new capital gains rate is 20%. For those with incomes under $450,000, the old 0% and 15% capital gains rates were made permanent. For many, 0% sounds like a funny number, but for couples with 2013 taxable income under $72,500 ($36,250 for individuals), the 0% rate applies.  The ATRA also changed qualified dividend income to follow capital gains rates. Thus, qualified dividends are taxed at 15% up to $450,000 in taxable income, and then at 20% after that. 

But Wait, There's More: The New Medicare Tax

Now, consider the extra Medicare tax in the Affordable Care Act. Starting in 2013, there is an extra3.8% Medicare tax on net investment income (which includes capital gains and dividends) for couples whose modified adjusted gross income (MAGI) is over $250,000 ($200,000 for individuals). With this new tax, the real capital gains tax for couples is 18.8% (15% plus 3.8%) if their MAGI is over $250,000 and 23.8% if their taxable income jumps to $450,000. Note the difference between "MAGI" and "taxable income" since this will trip many people up.

Tax Planning Thought #1

From a retirement income standpoint, the fact that we still have the 0% and 15% tax brackets on capital gains is great news. In retirement, many people can keep their income down by delaying Social Security benefits or other income. In those years, selling assets that have a gain so that the gains fill up the 0% bracket (as noted above, up to $72,500 of taxable income for couples in 2013) can be a big win. Even if you go above that, the 15% rate is better than most of us expected.

Tax Planning Thought #2

For couples with MAGI over $250,000 ($200,000 for individuals), the new 3.8% Medicare tax on net investment income means some people will pay a higher tax on capital gains (effectively 18.8%). Since the extra 3.8% is based off MAGI and not taxable income, itemized deductions (like charitable gifts, property taxes, etc.) will not help you reduce your income and avoid the tax. But if you are at this income level there is an opportunity to gift IRA assets to charity (assuming you are over age 70½) instead of taking the required minimum distribution (RMD) and having that included in your MAGI.

Tax Planning Thought #3

For couples with taxable income over $450,000 ($400,000 for individuals) there really is no 20% rate, since it jumps directly to 23.8% (20% capital gains rate plus 3.8% Medicare tax). But at this level, due to a phase out of itemized deductions and personal exemptions, the real tax is slightly higher. For these individuals in particular, tax deferral through 401(k) contributions has a bigger impact. In taxable accounts (like standard brokerage accounts), low turnover investments (like passive investing) will help.

Annual Planning More Important Than Ever

The interplay of regular income and capital gains/dividend income is going to make annual planning even more important, especially if you can control when you take certain income, like IRA distributions or capital gains. Take the time talking to your financial advisor and accountant now so that you are not surprised later.