Three Reasons Uncle Sam Took More Money from Your Pocket in 2013

Many Americans made more money in 2013, thanks in part to last year’s soaring equity market and continuing economic recovery. Partly as a result, however, many Americans will be writing bigger checks to Uncle Sam come April 15. Here are the three things most people overlooked in anticipating their 2013 tax bill:

1. Tax rates went up

Two big changes took effect January 1, 2013 that raised rates substantially for relatively high earners.  The Patient Protection and Affordable Care Act of 2010 imposed a new, 3.8% net investment income tax, and the American Taxpayer Relief Act of 2012 created a top federal bracket of 39.6%. Together, these two laws created a 43.4% top federal tax rate for taxable interest, non-qualified dividends, and short-term capital gains, and a 23.8% top federal tax rate for long-term capital gains and qualified dividends.

If you are a high-income earner, these rate hikes substantially increased your tax bill for 2013.

2. Less tax-exempt bond income

Municipal bond yields hit a 60-year low in early 2013. Investors, especially retirees, who rely on their portfolio for living expenses had to find other income sources—taxable income sources—to fund spending.

The good news is that the robust stock market gave retirees the option of either selling stocks at a gain or taking larger distributions from retirement accounts. The bad news is that these folks have to pay more taxes if they withdrew this money for spending.

3. The bull market ate your tax loss carry forwards

Every cloud has a silver lining. The deep losses that many investors incurred in 2008 and early 2009 meant that investors could carry forward their losses to offset subsequent gains. But after a phenomenal bull run in the equity market from 2009 to 2013, many investors found in 2013 that they no longer had any old losses left to offset their gains.

Look on the bright side. While higher tax rates are the new reality, you’re highly unlikely to have another tax surprise next April. With Congressional elections scheduled for November, Washington is very reluctant to make major changes to the personal income tax in 2014.

That’s all the more reason to reduce your tax bill systematically by using tax strategies that either defer taxes or avoid taxes altogether.

If you manage your portfolio with after-tax return as a goal, you may be able to generate tax-efficient income, avoid short-term gains (which are subject to higher tax rates) and harvest losses that allow you to defer capital gains, where possible. Importantly, this approach focuses on your overall outcome after tax:  you don’t want the tax tail to wag the investment dog.

Often, investors scramble in early April to find a way to cut their tax bill.  They are generally more successful at reducing taxes when they implement a tax-aware investment strategy the year before. The time to start managing your 2014 taxes is now.

The views expressed herein do not constitute, and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.

Tara Thompson Popernik, CFA, CFP®

Director of Research—Wealth Planning and Analysis Group
Tara Thompson Popernik was named the Director of Research for the Wealth Planning and Analysis Group in 2011 and is responsible for leading research initiatives on investment planning and asset allocation issues facing high-net-worth families, family offices, and endowments and foundations. Previously, she was a wealth management specialist, and before that she was a senior investment planning analyst. Prior to joining the firm in 2003, Popernik was a paralegal in the Capital Markets Group of Cadwalader, Wickersham & Taft. She earned a BA with honors in comparative literature from Dartmouth College. Popernik is a Chartered Financial Analyst charterholder and a CERTIFIED FINANCIAL PLANNER™ professional.

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