Six Steps to Protect Your Investment Income from the Taxman

With April 18 sneaking up on you, now is a good time to remember the words of investment legend John Templeton. All investment success should be measured the same way: high net returns, after costs, after inflation… and after taxes.

The current administration has made this far more difficult.

Obama raised the top short-term capital gains tax rate from 35% to 39.6%, the top long-term capital gains tax rate from 15% to 20%, and the top tax on dividends from 15% to 39.6%. There is also an additional 3.8% tax on dividends and capital gains to pay for Obamacare.

[ad#Google Adsense 336×280-IA]Under Obama, the top tax rate on your dividends and realized gains has gone from 15% to 43.4%, a 189% increase.

This is a double tax on capital since U.S. corporations are already taxed at the highest rate in the developed world.

And many states pile on with additional taxes on dividends and capital gains.

The affluent can’t even leave this mortal coil unmolested.

Obama also raised the death tax rate from 35% to 45%.

(It’s worth noting that the federal government allows the rich to blow their fortunes on sports cars, exotic trips and dancing girls. It only prohibits them from passing along what they’ve accumulated over a lifetime to their children and grandchildren.)

Let’s hope that our next president turns out to be more investor-friendly.

However, that won’t be the case if Hillary Clinton is elected. (And current national polls show she is most likely to win.) Clinton has proposed doubling the top tax rate on long-term capital gains to 43.4%. This would be unprecedented. No one has ever raised capital gains taxes by 82.3% in one fell swoop.

If you want to achieve and maintain financial independence, you need to take the legal steps necessary to keep your annual tax liabilities to an absolute minimum.

Here are six basic steps for tax-managing your portfolio:

  1. If you seek investment income, invest in municipal bonds. Interest payments are exempt from federal tax, and right now you face an unusual opportunity: Muni bonds are yielding more than Treasurys. This won’t last forever. Take advantage of it.
  2. Minimize turnover in your nonretirement accounts. Taking gains on investments held less than a year means subjecting yourself to short-term capital gains taxes. Hold winners for at least a year, if possible. If you do, you’ll qualify for long-term capital gains tax treatment.
  3. If you do trade for short-term profits, it’s better to do it in your IRA or other qualified retirement plan. That way your short-term gains compound tax-deferred.
  4. Where possible, offset realized capital gains with capital losses. (You can buy the same securities back 30 days later.) And you are allowed up to $3,000 in additional losses against earned income.
  5. Use your IRA, pension, 401(k) or other tax-deferred account to own corporate and Treasury bonds (since interest income is taxed at the same rate as earned income) and real estate investment trusts (since REIT dividends are taxed the same way). As I wrote in my previous column, this is known as your asset “location
  6. If you invest in mutual funds, use index funds rather than actively managed funds in your nonretirement accounts. Index funds are more tax-efficient because changes to the index are rare. Managed funds usually have high turnover, and federal law requires them to distribute at least 98% of realized capital gains each year. That means you can get hit with a big capital gains distribution even when you haven’t sold a share – and even if the fund is down for the year. That hurts.

In short, taxes are high. But they may soon go a lot higher still.

But take the steps I’ve outlined here and you will assure yourself of higher real-world, after-tax returns.

Good investing,



Source: Investment U