With all the buzz around the fiscal cliff and the Bush tax cuts that are set to expire in 2013, what tends to get overlooked is a tax that will definitely take effect in the new year: the 3.8% tax on investment income.
Congress passed the 3.8% tax in 2010 to add an estimated $210 billion of funds into the Patient Protection and Affordable Care Act (PPACA) and Medicare overhaul, and the new tax is scheduled to go into effect on Jan. 1, 2013.
“We know this is meaningful, and it’s going to happen,” said Katie Nixon, chief investment officer in Northern Trust’s wealth management business, at a media briefing in New York.
(Click to enlarge Nixon’s chart, below, “New Medicare Related Taxes: Effective January 1, 2013,” for her 3.8% tax explanation.)
As a result, advisors are getting their clients ready now for the inevitable and helping them decide whether to sell any assets before the end of the year. The challenge is getting clients to take action now.
Indeed, the level of resistance to taking action can be seen in Nationwide Financial’s recent survey showing that most affluent investors have no plans to meet with their advisors to discuss tax code changes even though the vast majority, 88%, said they are confident in their advisor’s ability to help them prepare for those changes.
Best time to plan is now
“The 3.8% tax doesn’t relate to the fiscal cliff. It relates to Obamacare,” said Joseph Perry, a New York-based partner-in-charge of tax and services for Marcum LLP, an accounting and advisory firm.
“The key,” Perry added, “is for people to reach out now to their accountants and financial advisors to plan for the year-end to legally reduce the amount of taxes they would pay in order to put more money in their pocket. What we find at Marcum is that clients aren’t focused on the 3.8% tax. We’re recommending them to get their financial advisors involved and sometimes their attorneys.”
According to the congressional Health Care Caucus’ information site, the new tax will be imposed on unearned net investment income, including capital gains from stock sales, dividend income, bonds, mutual funds, annuities, loans and home sales. People subject to the tax are individual filers who earn adjustable gross income of more than $200,000 and married couples filing jointly with AGI of more than $250,000.
“In its simplest form, if you have a single person who receives $50,000 in interest income, that person will get taxed. The tax includes capital gains, but it doesn’t include salary, bonus, pension or IRA,” Perry said.
‘People are overreacting’
Rusty Vanneman, chief investment officer of CLS Investments, based in Omaha, Neb., said his firm has fielded “big questions” from worried financial advisors and brokers who work with individual investors.
“People are overreacting and talking about selling in 2012, thinking if they sell this year they don’t have to pay next year. Yes, that’s true, but if you sell now and take gains, you don’t have money working for you next year,” Vanneman noted. “Selling now is overly simplistic, but if you were going to sell something anyway, then you should do it this year instead of next. But you don’t have to rush and sell stock if you were planning to hold it a long time.”
Vanneman added that many money managers who typically reallocate assets in January will rebalance portfolios in December instead, and he predicted that there might be an overreaction in the selling of dividend stocks. In fact, he said, dividend stocks have outperformed the market since Obama’s re-election, and if there is a selloff, it could present a buying opportunity for savvy investors.