Investment tax planning should be addressed

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By Doug Awad

Investment planning can be important for several reasons. However, any discussion of investment planning is incomplete without a thorough understanding of the applicable income tax ramifications. Tax planning can help you reduce the cost of your investments. Once you’ve created an investment plan to work toward your various financial goals, you should take advantage of the tax rules to ensure that you maximize after-tax return. In other words, your goal is to select tax-favorable investments that are consistent with your overall investment plans. In order to engage in investment tax planning, you need to understand how investments are taxed and how to compare different investment vehicles. You also need to know how your own tax situation affects the taxation of your capital assets. Caution: Investment choices should not be based only on tax considerations.

How does investment tax planning work? Similar investments may carry substantially different tax costs. A myriad of investment vehicles are available to you. You can invest in stocks, bonds, mutual funds, money market funds, real estate, commodities, or your own business. Investment earnings are taxed in many different ways. Consequently, some investments earn less after tax than others. By taking advantage of these differences, you may save money.

How are your investments taxed? 1. Capital Gains and losses: While you hold an asset (e.g. your home, stocks, bonds, mutual funds, real estate, collectibles), you will not pay taxes on any increase in value. However, when you sell or exchange the asset, you will realize a capital gain (if you sell it for a profit) or loss (if you sell it for less than the asset’s cost). If you sell an asset after only a year or less, you will have a short-term capital gain. Short-term capital gains are taxed at ordinary income tax rates (your marginal rate). If you won the asset for more than a year before you sell it, you will have a long tem capital gain. Long-term capital gains tax rates are generally more favorable than ordinary income tax rates (for most assets). Currently, the highest ordinary income tax rate is 35 percent while the highest long-term capital gain rate (for most assets) is 15 percent. That’s a difference of 20 percent. Thus, holding an asset for long-term growth is a tax-saving strategy.

Caution The Jobs and Growth Tax relief Reconciliation Act of 2003 and the Tax Increase Prevention and Reconciliation of 2005 reduced long-term capital gains tax rates for sales and exchanges made between Ma6 6, 2003 and Jan. 1, 2011. These rates are 15 percent for taxpayers in the marginal rate of 15 percent or higher, and 5 percent (0 percent in 2008-10) for tax payers in the 15 percent and 10 percent brackets In 2011, the rates revert back to 20 percent and 10 percent. You may want to time the sale of highly appreciated assets to take advantage of the lower rates. 2. You may offset capital gains with capital losses (short-term gains against short-term losses and long-term gains against long-term losses). If you have more losses than gains in a given year, you may offset up to $3000 ($1,500 if married filing separately) against ordinary income. Remaining losses can be carried forward into future tax years.

Qualified Dividends.        

Qualified dividends are dividends received during the tax year by an individual shareholder from a domestic corporation or a qualified foreign corporation. Under the 2003 and 2005 Tax Acts, effective for the tax years 2003-2010, such dividends are taxable a the same rates that apply to long-term capital gains. This tax treatment applies to both regular tax and alternative the minimum tax. Absent further legislative action, dividend tax rates revert to pre-2003 Tax Act levels (i.e., they will be taxed at ordinary income tax rates) beginning in 2011. Eligible dividends include dividends received directly from a domestic corporation or a qualified foreign corp. as well as qualified dividend passed through to investors by stock mutual funds, other regulated investment companies, partnerships, or real estate investment trusts (REITS). Distributions from tax-deferred vehicles, such as IRAs, retirement plans, and annuities do not qualify even if the funds represent dividends from stocks.

Ordinary Investment Income Ordinary income consists of any investment income that is not capital gain income, qualified dividends, or tax-exempt income, and is taxed at ordinary income tax rates. Investment income is generate by investment property such a bonds and bond mutual funds. Dividends that are not qualified are also taxed as ordinary income tax levels.

Investment Expenses.

If you borrow money to buy investment property, you probably pay investment interest. Investment interest may be used to offset investment income only. Excess investment interest may be carried forward to future years. Other investment expenses (e.g. commissions, fees) are deductible as in itemized deduction on Schedule A and are subject to the 2 percent limit.

If you have any questions, please contact Doug at 352 854-5855 or by e-mail at Doug.Awad@raymondjames.com.

This information was partially developed by Forefield, Inc., an independent third party. It is general in nature, is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or solicitation to buy or sell any security. Investments and strategies mentioned may not be suitable for all investors. Past performance may not be indicative of future results. Raymond James and Assoc., Inc. does not provide advice on tax, legal or mortgage issues. These matters should be discussed with an appropriate professional.

Doug Awad is a Financial Advisor for Raymond James and Associates.