Traditional tax planning 'turned on its head' this year

Medicare surcharge for high earners upends conventional strategies; just do the opposite

Sep 4, 2012 @ 3:50 pm

By Liz Skinner

Few options exist for wealthy Americans looking to reduce their exposure to the 3.8% health care surcharge on investment income, coming next year. Recommendations for lowering the levy fly in the face of normal tax planning, according to a financial adviser.

“The tax planning of old is going to be turned on its head this year,” said Art Graper, a financial planner and managing director of Atlantic Trust Private Wealth Management, a unit of Invesco Ltd., which manages $18.9 billion in assets. “For the remainder of this year, throw out the window all the usual advice and basically do the opposite.”

Mr. Graper, who has worked with high-net-worth clients for 16 years, said he offered such advice to few clients in the past. He is giving it more now, however, because of the increase in the capital gains tax rate to at least 18.8% next year — a rise stemming from the health care surtax. The capital gains level could go to as high as 23.8% if Congress doesn't extend the Bush-era tax cuts by Dec. 31.

First and foremost, Mr. Graper suggested, deal with highly appreciated assets and pay today's 15% capital gains tax or consider donating the asset to charity, which most likely won't have to pay on the investment gains.

Passage of the Affordable Care Act in 2009 means a 3.8% tax will be added to capital gains and other investment income for families earning $250,000 or more, or individuals making $200,000. The proceeds from the new tax will be used to help fund the Medicare system. It's one of the few measures that experts consider a definite for 2013 because of the uncertainty over whether Congress will extend other tax cuts.

Mr. Graper's recommendations include buying tax-exempt municipal bonds, converting individual retirement accounts to Roth IRAs — distributions aren't taxed — and seeking rental real estate, which typically generates passive losses because of depreciation deductions.

In addition, he recommended structuring businesses as S corporations, which don't have to pay self-employment taxes (also scheduled to go up under the health care bill). Consider oil and gas investments, which have “very favorable” tax preferences.

Finally, installment sales that defer recognition of a gain over a longer period could help taxpayers keep income under the federal thresholds that trigger the health care surcharge, Mr. Graper said.

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