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What’s Different for 2013?

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Grace S. Yung

Considerations for Texas and your future investments.
by Grace S. Yung

With the hotly debated 2012 presidential election behind us, investors can now get down to business in terms of how they will proceed with the handling of their assets going forward—especially in light of taxes and the fiscal cliff.

One issue involves the new 3.8% Medicare surtax that took effect on January 1, 2013, that will now be levied on the lesser of one’s modified adjusted gross income (MAGI) or the net investment income for individuals who have income that is above $200,000 per year.

Yet, although much has been said regarding the large tax hike for those who earn higher incomes, the truth is that many individuals who earn less than the $200,000 annual amount could also be subject to higher tax rates starting in 2013.

This tax hike not only includes tax on wages, but also on dividend income and long-term capital gains. As most in the LGBT community must file taxes as “unmarried” individuals, the marginal income tax rate differences between 2012 and 2013 look like this:

Annual income of:

But not over:

2012 Rate

2013 Rate

$0

$8,700

10%

15%

$8,700

$35,350

15%

15%

$35,350

$85,650

25%

28%

$85,650

$178,650

28%

31%

$178,650

$388,350

33%

36%

$388,350

35%

39.6%

There will also be some differences between 2012 and 2013 for those who earn dividend income and/or long-term capital gains:

Maximum Rates

2012

2013

2013 (incl. Medicare

contribution tax)

Long-Term Capital Gain

15%

20%

23.8%

Qualified 5-Year Capital Gain

15%

18%

21.8%

Maximum Rates

2012

2013

2013 (incl. Medicare

contribution tax)

Qualified Dividend Income

15%

39.6%

43.4%

Qualified Dividend Income

35%

39.6%

43.4%

Overlooking the impact that taxes could have on your income and your investment returns could possibly lead to losing more of your investment dollars to Uncle Sam than necessary. With this in mind, there are several areas where investors should consider implementing tax and investment strategies that could essentially help in lowering their tax liability in both the short- and long-term.

What Investors Can Do

There are some key areas where investors need to determine where and how they can come out ahead when comparing current and potential future tax consequences. The first involves reducing your modified adjusted gross income.

In doing so, one method could be to maximize contributions into pretax retirement plans such as a 401(k) or 403(b). In this case, you may be able to reduce your adjusted gross income below the annual income threshold, therefore reducing the total amount of taxes that will be due.

For instance, in 2013, individuals can contribute up to $17,500 to a 401(k) plan—and, for those who reach age fifty before the 2013 calendar year is over, an additional $5,500 in “catch-up” contribution can also be made. Likewise, these same amounts also apply to those who contribute to a 403(b) plan.

Some of the more complex issues may come to light with the net investment income part of the new tax laws. Here, another potential tax strategy involves shifting some investments that have taxable earnings over to other alternatives such as municipal bonds (muni’s) where earnings will not be included in your calculations for net investment income. In the case of municipal bonds, interest income in most cases is tax free; however, capital gains that are obtained through bond funds are typically subject to taxation. (Municipal Bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free, but other state and local taxes may apply.)

Investors seeking more leeway on managing investment-related tax issues may also opt for using separately managed accounts or money managers. These too may be more tax efficient as compared to simply investing in a mutual fund, because investors can work directly with their money manager via their financial advisor in order to more closely manage annual investment gains and/or losses. This can allow the investor much more customization when it comes to what is invested in their portfolio and when to actually take the gains or losses on their invested funds.

Another possible strategy for those who plan to hold investments that pay taxable dividends or that produce taxable interest is to hold these particular funds in tax-deferred accounts such as an IRA (Individual Retirement Account).

The Bottom Line

Today, having a tax-smart investment strategy is even more important than ever. While the future of one’s tax consequences may still not be completely certain, it is best to begin taking the necessary steps that could help in reducing the impact of the new legislation.

While doing so, however, it is essential to keep in mind that all situations call for a plan that fits in with your specific financial goals. Given this, all planning should be conducted using qualified professionals who are well versed in the areas of tax and finance.

Grace S. Yung, CFP, is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial LLC in Houston.

See other MoneySmart columns:

LGBT Partners… (December 2012 OutSmart)
Working around the denial of your government benefits

Future Tax Rules Can Further Penalize LGBT Investors (November 2012 OutSmart)
But there is still time to act

Protecting your Wallet and your Heart (October 2012 OutSmart)
How and when to keep assets separate—even when you’re madly in love

Domestic Partner Tax Deductions in Home Ownership (September 2012 OutSmart)
With today’s historically low interest rates, it’s certainly a great time to either purchase or refinance a home.

Dying Intestate (August 2012 OutSmart)
Could you be leaving the state in charge of distributing your assets?

Protecting the Things that Matter (July 2012  OutSmart)
How those in the LGBT community can use life insurance planning strategies

When ‘I Do’ Becomes ‘I Don’t Anymore’ (June 2012 OutSmart) 
Ensuring both partners’ fair share with a Domestic Partnership Agreement

Retirement (May 2012 OutSmart)
Using annuities can provide lasting income for both domestic partners: When depending on a partner’s retirement income, annuities can offer the perfect solution

Financial and Tax Planning Issues for Domestic Partners (April 2012 OutSmart)
Is Uncle Sam getting a bigger chunk of your income and wealth?

The Real Cost of Long-term Care (February 2012 OutSmart)
How LGBT caregivers are paying the price

Gay Money Matters (part 1) (February 2010 OutSmart)
Domestic Partners: Estate and Tax Planning

Gay Money Matters (part 2) (February 2010 OutSmart)
Protecting your assets . . . even when the rules don’t

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Grace S. Yung

Grace S. Yung, CFP, is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial LLC in Houston and was recognized as a “Five-Star Wealth Manager” in the September 2017 issue of Texas Monthly.
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