How to Deal with the Capital Gains Tax 2013 Increases

Capital Gains Tax 2013Tax efficiency is a key goal of any investment strategy. Over time, investors have become better at avoiding taxes by investing in tax efficient ETFs, and tax shelters like real estate, master limited partnerships, and municipal bonds.  This is a great strategy if looking to avoid the capital gains tax 2013 increases.

Avoiding capital gains taxes is so critical to investment performance that it absolutely cannot be ignored. Most active fund managers underperform the market in part because they generate more and higher tax liabilities for investors. Individual investors are likely to lag their retirement needs because they fail to account for capital gains taxes when making an investment.

As a reminder, here are the capital gains tax 2013 increases:

  • Long term capital gains will be taxed at:
    • 20% for individuals making over $400,000
    • 15% for individuals in the 25% to 35% tax bracket
    • 0% for individuals in the 15% or lower tax bracket
  • Net investment income (Capital gains and dividends combined) over $200,000 will be subject to an additional 3.8% Medicare tax
  • Modified Adjusted Gross Incomes (MAGI) over $200,000 will be subject to additional 3.8% Medicare tax on all dividends and capital gains, regardless of the amount
  • Qualified dividends will now be taxed at 20%, instead of 15%, for individuals earning more than $400,000, while ordinary dividends will be taxed at your current income tax rate


Four Ways to Look at Capital Gains Tax 2013

The capital gains tax isn’t just a tax assessed on earnings. It’s a tax that substantially changes the way investors should and do allocate capital to the best investments.

The capital gains tax is really four different kinds of investment taxes rolled up into one:

    1. Inflation Tax – Investors have to account for the fact that the capital gains tax is, in a way, a simple tax on inflation. While investments of all kinds have beaten the rate of inflation in the long-haul, the rate of inflation is anything but constant. If one earns 8% per year in an environment with 3% inflation, investors incur a tax burden on the total return, not just the return excluding taxes.
    2. Transaction Tax – The capital gains tax is really a tax on transactions, not a tax on gains. Gains by themselves are not taxed at the capital gains tax rate. Rather, collected gains from the sale of a security or investment are taxed. The difference is important. Swapping one winning stock for a new pick which you believe will perform even better is costly. Each swap will cost you as much as 23.8% in capital gains taxes. Don’t move your money unless your new hot pick is at least 23.8% better than your current pick.
    3. Wealth Tax – The capital gains tax is truly a wealth tax. Seeing as individual tax payers are taxed differently depending on their income (high income households face 23.8% taxation vs. 10% in others) the capital gains tax is a wealth tax. Investors in lower tax brackets win with dividend stocks and taking regular capital gains, much like investors in high tax brackets receive more from municipal bonds and MLPs.
    4. A Metals Tax – One of the many reasons gold and silver make poor long-term investments is because of they are taxed as collectibles at income tax rates rather than more favorable capital gains rates. Uncle Sam really doesn’t care for your investments in gold, silver, or fine art, and you’ll pay dearly in taxes for investing in any of the three.


Wise Up in 2013 or Pay More in Taxes

There’s a clear cut answer to higher capital gains taxes in 2013:

  • Consider very carefully taking any profits in individual stocks if the alternatives are not substantially better.
  • Move money into tax-advantaged accounts, especially if you’re invested in dividend paying stocks, or stocks which you do not intend to hold for a very long period of time.
  • Rebalance by adding funds to realign your portfolio rather than taking profits and moving funds from one asset class to another.
  • Evaluate very carefully the role of inflation in your investments and how it impacts the taxes you pay on returns.

Capital gains taxes will likely keep going higher. It’s time to seriously think about smarter tax strategies to keep more of your returns in your own pocket.

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  1. says

    Good tips! It always amazes me when I speak with people and they don’t realize that taxes play a huge role in their transactions, especially if done in a non tax advantaged account. Great point to add cash to a portfolio as opposed to taking profits, I like to do that as much as possible.

    • says

      Yeah, taxes in taxable accounts are a killer. You have to be much choosier about what you’re buying, since you want to have to take profits as few times as you can. Buying one stock for the long haul would be much better than buying and replacing one stock 10 different times.

  2. says

    Are you sure on the Ordinary vs. Qualified part? I didn’t see that change.

    On the rest: get in a time machine, go back to the last trading day of the year. Sell everything with a gain. Re-buy everything, resetting your cost basis. Profit!

  3. says

    JT, that was really informative, thanks for that! I found the concise changes for this year as well as the “Wise Up” section really helpful.

    I’m curious, how do you consider inflation into your investment choices? While the concept is pretty simple, the impact is rather complex.

    • says

      With inflation, I think it just becomes too easy to focus on pre-tax returns and completely forget about after-tax returns. CDs, for example, yield right at the current CPI inflation rate, but once you account for income taxes, you’re falling behind.

      I think adjusting to riskier assets earlier in your retirement plan is a good idea. You’re supposed to take more risk early, but take even more risk than more risk. In retirement, you’re likely to lose ground to inflation to keep your principle safe, so you have to make up for that loss in one way or another. I think it’s by being riskier and more aggressive in the early years.

  4. says

    If your gross income is below $200,000 you still have the same rate as in 2012. For the vast majority of people there will be no change in capital gains taxes and there is no reason for them to worry more about capital gains taxes then before.

    Technically, there is a capital gains tax decrease for 2013 since the old rates expired at the end of 2012 and capital gains and dividends would have been taxed at an even higher rate.

    • says

      You fall into the Republican argument where they left rates go up for a few hours just so they could say they voted for a tax decrease. But you’re correct – rates would have gone up without intervention.

  5. says

    Luckily for me I am not in those upper echelon tax brackets so nothing has changed for my family. Although one day I will be in that bracket but hopefully by then our politicians and economists in Washington will wise up and see that raising taxes does not necessarily increase tax receipts!

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