Prepare now for looming investment income tax

There's still time to strategize to minimize impact; trusts likely to feel the brunt
SEP 16, 2013
Tax gurus have been sounding the horn on the 3.8% net investment income tax — a levy that will hit top earners and any income coming from their trusts — but investors have been slow to react. The 3.8% tax went into effect this year and applies to either net investment income from taxable interest, nonqualified annuities and dividends, or to modified adjusted gross income over $200,000 for single filers or $250,000 for joint filers — whichever is less. Clients won't see the raw effects until next April when they file their tax returns. As with all things tax-related, they're dragging their feet in the meantime. “The truth of the matter is that it hasn't come to people's attention, because they haven't filed a return with it yet,” said Charles Aulino, director of financial planning at The Glenmede Trust Co. NA. “I think they'll see the impact next April when they file returns.” “You'll see a lot of people won't pay attention until they're ready to get hit with the tax,” added Gavin Morrissey, vice president of wealth management at Commonwealth Financial Network. That means that there's still time to strategize. Certain trusts and estates that have undistributed net investment income and produce more than $11,950 in income will also be subject to the surtax. To add insult to injury, trusts that generate more than that amount of income will also be in the top income tax bracket of 39.6%. Trusts will suffer the brunt of the 3.8% surtax because they don't have to produce much income in order for it to apply — only $11,950, compared with the $200,000 threshold for single filers. “The surtax applies at the trust level to the extent there is undistributed investment income and capital gains,” said J. Christopher Raulston, a wealth strategist at Raymond James Financial Inc. One possible strategy is for trustees to distribute income to the beneficiaries, considering individuals and married couples have a higher income threshold to meet before they can be subject to the tax, he recommended. Still, traps await the unwary: Investors and their financial advisers must make sure they work within the boundaries of the trust's document and state law when working out distribution plans, Mr. Raulston cautioned. They must also bear that in mind when trusts push income out to beneficiaries, particularly those who are at risk of litigation and creditors. Once the money is out of the trust, it might be up for grabs. It might also be a good time to check the trust documents and ensure that they spell out the terms under which the trustee can make the distributions. “If not for the surtax, you'd be able to keep the income in the trust, and nobody can touch it,” Mr. Raulston said. Whether clients react in a timely manner is still up in the air, but one thing is for sure — the 3.8% surtax will catch many people flat-footed next April. “You can run through the highest tax brackets and get the surtax with very little effort,” Mr. Morrissey said. “If the trustee isn't paying attention to that, they're going to have quite a surprise when they file.”

Latest News

Federal judge dismisses Eltek manipulation lawsuit against Morgan Stanley Smith Barney
Federal judge dismisses Eltek manipulation lawsuit against Morgan Stanley Smith Barney

Nine-month electronic trading freeze and share lending program at the center of dismissed claim.

RIA wrap: Dynamic strikes South Carolina deal to reach $7B AUM milestone
RIA wrap: Dynamic strikes South Carolina deal to reach $7B AUM milestone

Meanwhile, Rossby Financial's leadership buildout rolls on with a new COO appointment as Balefire Wealth welcomes a distinguished retirement specialist to its national network.

Rethinking diversification amid a concentrated S&P 500
Rethinking diversification amid a concentrated S&P 500

With a smaller group of companies driving stock market performance, advisors must work more intentionally to manage concentration risks within client portfolios.

Merrill pays second settlement to former Miami Dolphins player, client of ex-broker
Merrill pays second settlement to former Miami Dolphins player, client of ex-broker

Professional athletes are often targets of scam artists and are particularly vulnerable to fraud.

Schwab touts AI as its biggest growth lever at investor day
Schwab touts AI as its biggest growth lever at investor day

The brokerage giant tells Wall Street it will use artificial intelligence to reach clients it has never been able to serve — and turn the technology's perceived threat into a competitive edge.

SPONSORED Beyond wealth management: Why the future of advice is becoming more human

As technical expertise becomes increasingly commoditized, advisors who can integrate strategy, relationships, and specialized expertise into a cohesive client experience will define the next era of wealth management

SPONSORED Durability over scale: What actually defines a great advisory firm

Growth may get the headlines, but in my experience, longevity is earned through structure, culture, and discipline