9 Ways to Beat the Medicare Surtax - Part 2 - Rodgers & Associates
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9 Ways to Beat the Medicare Surtax — Part 2

Giving to charity photo


The year 2013 brought new taxes for upper income taxpayers as well as a return of the higher tax rates from 2001. The top tax rate on wage income can be as high as 43.4% when combing the new rates in American Taxpayer Relief Act of 2012 (ATRA12) with the new surtax from the 2010 healthcare reform act. The stealth increases created by restoring the phase-out of itemized deduc­tions known as Pease Limita­tions and personal exemp­tions (PEP) can add another 2–6% to the top rate.

Minimizing the impact of these tax increases requires a plan and strategy for imple­men­tation. Last week we began our series on beating the new taxes. This week we will explore 3 more strategies.

9 Ways to Beat the Medicare Surtax – Part 2

4.) Fund Chari­table Goals with Appre­ciated Assets – A strategy for managing capital gains involves the use of a donor advised fund (DAF) for taking gains and fulfilling a client’s chari­table goals. A DAF is a separate account operated by a section 501(c)(3) organi­zation, which is called the sponsoring organi­zation. This organi­zation has been created for the purpose of managing chari­table donations on behalf of an organi­zation, family, or individual. A DAF provides an easy-to-establish, low cost, flexible vehicle for chari­table giving. In exchange, the donor enjoys a conve­nient, cost-effective, and tax-advantaged way to make chari­table gifts through the DAF.

One of the overlooked advan­tages of using a DAF is the ability to manage your capital gains. An investment position with a long term gain should be moved to the DAF before it is sold. The gain is not taxable in a DAF and the proceeds can be used to meet future chari­table commit­ments. You simply hold the sale proceeds in the DAF until you determine what charity will ultimately receive the proceeds. DAFs can be used for rebal­ancing or to remove positions that have reached full value. Invest­ments with unrealized losses should be sold outright to harvest the loss.

Appre­ciated assets trans­ferred to the DAF qualify as a chari­table contri­bution. The donor may receive a federal income tax deduction up to 30% of adjusted gross income (AGI) for appre­ciated securities. Unfor­tu­nately some of this deduction may be phased out if the taxpayer is subject to the Pease limitation.

5.) Establish a Chari­table Remainder Trust — What if you need the income from an appre­ciated asset and can’t afford an outright gift to a DAF? This strategy calls for the use of a special kind of trust known as a chari­table remainder trust (CRT). The donor sets up an irrev­o­cable trust naming a charity (or charities) as the benefi­ciary. Appre­ciated assets are trans­ferred to the trust quali­fying as a completed gift. The CRT is required to make payments to the donor at least annually during the term of the trust. Any remaining principal is then distributed to one or more charities at the end of the trust’s term. The IRS allows a partial chari­table deduction of the amount contributed and the income is only partially taxable.

Funding the trust with appre­ciated assets avoids capital gains tax when the assets are sold. The proceeds can then be reinvested into income-producing assets providing greater diversity, less risk and perhaps more income than the one origi­nally donated. This CRT pays the donor a fixed percentage — 5% at minimum — of the trust assets deter­mined each year. The assets may go up or down in value, and the annual payout will fluctuate accord­ingly. The donor shares in the investment risks and rewards through the changes in the payout each year. The trust can be set up as a chari­table remainder annuity trust (CRAT). A CRAT pays out a fixed percentage of the initial value of trust assets, so the annual distri­b­ution remains constant through the trust’s life.

6.) Switch to Tax-Efficient Invest­ments — The most tax-efficient investment strategy is simple: hold shares for as long as possible, thus deferring the taxes on your capital gains until you sell. An extremely tax-efficient portfolio would therefore be a selection of growth oriented assets held for the long haul. Assets that grow (as opposed to income producing) are preferred, because they tend to pay little or no dividends. Your return would be mostly made up of long-term capital gains. Best of all, you’d get to decide when you pay the tax by choosing when to sell them.

Among growth oriented assets, tax-efficient funds are preferable because they offer diver­si­fi­cation. The most tax-efficient funds are index funds, exchange traded funds and those funds with the mandate of operating tax efficiently. Tax-efficient investing requires active involvement. That starts with looking for tax-efficient mutual funds as discussed above. The portfolio will also need to be monitored so losses are harvested to offset gains when appro­priate. It’s important to keep in mind that investing tax-efficiently is a balancing act. The reality is there will always be trade-offs, your overar­ching goal should be to minimize taxes while still attempting to achieve superior investment returns. Some investors make the mistake of holding even when it’s not wise to do so, rather than selling if the sale produces a capital gain. Remember, the tax decision should never overrule the investment decision. Assessing the tax conse­quences of your invest­ments at each stage—contribution, accumu­lation, and distribution—is the key to success in the world of tax-advantaged investing.

Part 1 | Part 3

Rick’s Insights

  • Combine chari­table goals with controlling capital gains by using either a DAF or Chari­table Remainder Trust.
  • Unpre­dictability of income can be elimi­nated in a chari­table trust by creating it as a chari­table remainder annuity trust.
  • Tax-efficient investing is easily achieved by paying attention to where invest­ments are held in taxable vs. tax-deferred accounts.