Stan's Smart Seven: Avoiding the New Tax on Investments

Have you ever thought about some smart strategies to consider now and in the future to avoid paying the Medicare surtax on investment income? Below, take a look through my TOP SEVEN SMART TIPS for avoiding the new tax…

1. Sell assets with large gains in 2012. If you're likely to sell the assets in the next few years, you might want to sell by December 21, 2012. You'll lock in the 15% maximum long-term capital gains rate, avoid the 3.8% Medicare surtax, and avoid triggering the surtax on other investment income.

It's a tough call, because you don't want taxes alone to dictate investment decisions. The surtax, however, does increase the cost of holding assets for another year or two and might tip the scale toward selling sooner instead of later.

2. The surtax will apply to the sale of your business.

That's an extra 3.8% in addition to the other taxes and cost of selling. Those who were considering sales in the near future should consider the benefits of closing a deal by the end of 2012.

3. Tax-exempt bonds. When your income is high enough to trigger the surtax regularly, shifting some income investments to tax-exempt bonds instead of some other types could really pay off. Tax-exempt bonds both lower your MAGI and avoid the surtax.

4. Convert to Roth IRAs. Distributions from traditional IRAs and pensions are exempt from the surtax, but distributions from them count in your MAGI and can trigger the surtax on your investment income.

When retirement plan distributions combined with your other income are likely to trigger the surtax, you'll save a lot of money long-term by converting traditional IRAs to Roth IRAs. Roth IRA distributions are not included in the MAGI. It's a factor that could tip the balance in favor of converting IRA's if the benefits of a conversion were on the borderline before the new law.

Keep in mind, however, that in the year of conversion, the amount converted will be included in your MAGI and could trigger the surtax on other investment income. So, carefully consider having conversions completed by the end of 2012.

5. Review deferred compensation strategies. A classic tax strategy is to defer income and taxes, especially on compensation. You might want to reconsider such strategies.

Deferring compensation from 2012 to 2013 or later could trigger the surtax on investment income, because the deferred compensation will be included in your MAGI.

6. Boost retirement plans. Since distributions from qualified retirement plans are exempt from the surtax, upper income taxpayers with some control over their situations, such as small business owners, might want to make greater use of qualified plans. Creating a traditional defined benefit pension plan, for example, will increase tax deductions now and generate future income that is exempt from the surtax.

7. Don't forget the other Medicare surtax in Obamacare. This is an additional 0.9% tax on wages, salaries, and self-employment income on top of the regular Medicare tax. (This tax does go to the Medicare trust fund). It's imposed on singles with total wages of more than $200,000 and married couples with more than $250,000.

This tax will be withheld by your employer or be part of the self-employment tax. It won't be separately listed on W-2s. This Medicare surtax is another reason to consider not deferring compensation past 2012, so be careful!

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The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice form an independent financial advisor. The content is derived from sources believed to be accurate.