Andy Friedman of The Washington Update has cast an experienced gimlet eye on all things Washington, from the presidential race (Andy Friedman: Indie Voters Crucial to Clinching Presidency; Trump Could Trip Up) to the Department of Labor’s fiduciary rulemaking (How to Kill DOL’s Fiduciary Rule: Andy Friedman) as reported on ThinkAdvisor.
In a recent white paper, Friedman — a former tax lawyer — writes about the federal tax situation, particularly for higher-income taxpayers, and argues that while the current Congress — and potentially future Congresses — might not increase tax rates, tax reform efforts (often called “loophole closing” ) could mean that investors will pay more in taxes.
“Taxes paid by high income investors are likely to rise as Congress over time eliminates favorable tax treatment of more items to pay for additional spending,” he writes.
Friedman argues that investors and their advisors should “take advantage of the current tax treatment of endangered items while it remains available.” Following are his eight tips to minimize taxes now:
1. Shield Investment Earnings From Taxes
To maximize the after-tax returns of investing, Friedman suggests using municipal bonds, master limited partnerships (MLPs) and real estate investment trusts (REITs), which provides investment income free in all or part from federal income tax. As an example, he cites a municipal bond paying 3% interest that produces a tax-equivalent yield of 4.6% for a taxpayer in the 35% tax bracket.
This is one tax loophole that Friedman believes won’t be closed by Congress, “although there can be no guarantee when predicting the whims of Congress.”
2. Consider Investments Providing Long-Term Capital Gains
Since the federal tax rate on capital gains and qualifying dividends “is about 45% lower than the tax rate on ordinary income,” Friedman suggests investors consider investments producing qualified dividend income, and do so long enough “to produce long-term capital gains” when they’re sold.
3. Harvest Tax Losses Now and Buy and Hold
Friedman counsels investors to take advantage of the tax deferral provided by buy-and-hold investment strategies, again to take advantage of the lower taxes on longer-term capital gains and also to harvest tax losses “throughout the year to shelter gains that are recognized.”
4. Pay Attention to the Basis of Holdings Before Selling
Friedman says that when investors are selling part of their holdings, “it pays to identify the particular lot that is being sold” so that assets with the highest basis are sold first.
5. Use Professional Managers to Maximize After-Tax Returns