By Sue Thompson, CIMA, Managing Director, Head of the Registered Investment Advisor Group, BlackRock
With just a month until the April 15th tax deadline, there's a good chance you're right in the midst of preparing your 2013 taxes. There's also a good chance your tax bill may be higher than you thought.
Why? Thank two new taxes that go into effect for the 2013 tax year. First, there's the new 0.9% "Additional Medicare Tax" on earnings above certain thresholds. Second, there's the separate new 3.8% net investment income tax. And if you hadn't heard of these new taxes before, you're not alone.
"I think the majority of people don't know about them," says Mark Balasa, a principal at fee-only wealth management firm Balasa Dinverno Foltz LLC in Itasca, Ill., and my go-to source for tax-related questions. "Somewhere between 50% and 75% of people are going to be surprised."
Unfortunately, there's not much you can do now to change your 2013 tax bill, aside from remembering to take all the deductions you qualify for. However, the same is not true for your 2014 bill, Mr. Balasa says. Here are three moves he suggests considering now to potentially lessen the impact of these new taxes next year.
Harvest losses. Though many investors intellectually understand the importance of tax loss harvesting, they still don't do it. Behavioral finance research showing that losses hurt more than gains can explain why. However, when it comes to lowering your 2014 tax bill, harvesting losses to offset gains is a great way to lower your taxable investment income. So, as 2014 progresses, be sure to periodically peruse your portfolio for losses. Depending on what happens in equity and bond markets this year and when you bought your holdings, you could have losses somewhere that you could harvest by selling the investments.
Opt for Municipal Bonds. Municipal bonds are exempt from federal taxes and most state taxes. In other words, whatever income you earn from them doesn't count toward your taxable investment income. And besides the tax advantages that come with munis, there are other reasons to like them. As my colleague Russ Koesterich, who is overweight the sector, points out in his monthly investment commentary, the fundamentals of municipalities continue to improve, and the asset class remains attractive given rising taxes.
Consider Roth IRAs. If you believe your tax rate is going to continue to increase, you may want to consider converting a traditional pretax retirement account into a Roth Investment Retirement Account (IRA), where the money can grow tax free. Qualified distributions from Roth IRAs aren't subject to taxes. Though you'll take a tax hit in 2014 for the conversion, you'll potentially help lessen your tax bill down the road.
So now that I've filled up your investing to-do list for this year, let's get back to the subject of your 2013 tax bill. I'll leave you with the number one mistake Mr. Balasa sees people making when it comes to taxes: forgetting to take all the deductions they qualify for.
Sue Thompson, CIMA, Managing Director, is Head of the Registered Investment Advisor Group, overseeing the firm's iShares and 529 sales efforts with registered investment advisors, family offices and asset managers. Sue is a regular contributor to The Blog. You can find more of her posts here.
Sources: Mark Balasa, BlackRock research