With the new tax rates in effect since the beginning of 2013, wealthier investors should take a fresh look at their investment strategies with an eye towards mitigating capital gains taxes to the extent possible. The top ordinary income bracket was 35% in 2012. Now, in 2013 it is a whopping 43.4% if you include the new 3.8% medicare surcharge for passive income on investment income for income levels over $200,000 for singles and $250,000 for joint marrieds.
That is an increase of 8.3% year over year. The 43.4% rate would apply for these well-to-do investors if they realize a short term capital gain. Where possible, look to extend your investment horizon to a greater than 1 year stretch qualifying you for the long term capital gain tax rate of only 23.8% (once again this number includes the normal 20% long term capital gain tax rate plus the new 3.8% medicare surcharge on passive investment income for high income earners.
The recent bull market now means investors are in the black on virtually all investments. It also means a capital gains tax bill upon sale. Remember capital gains taxes also apply to the stocks owned by mutual funds. Those capital gains taxes are passed on to the individual investors in the funds each year. Consider your mutual fund portfolio. Do your funds have considerable churn or turnover in stocks held? If so, that’s costing you each time the fund sells a position that is less than a year . Instead of the 23.8% long term rate, you’ll get slapped with the nearly twice as high 43.4% ordinary income rate. Where it fits your investment strategies, consider putting your investment dollars in mutual funds with lower portfolio turnover instead of funds that are churning their positions all the time and costing you tax dollars.
See these charts showing the new capital gains tax rates.
The new 3.8% tax surcharge on medicare is fully discussed here.
Another alternative to reduce the capital gains tax bill on investments is to invest in municipal bonds instead of fully taxable bonds or bond funds. Investors don’t pay federal taxes on income from municipal bonds. For tax reasons, munis are obviously more desireable in 2013 than they were in 2012.