Tax-managed portfolios can mean percentage points

By Stan Purvis

The Daily Record Newswire

The ongoing public policy debate on federal income and estate taxes has increased investor concerns. Investors are concerned about the uncertainty of new tax laws and the impact the tax increases will have on their lives and family.

The ballooning federal annual deficit and federal debt and how to best deal with it has a big impact on the debate. Under current tax law, taxes on investment income are scheduled to increase significantly in 2013 when 2012 tax rules revert back to the pre-2001 tax laws. Congressional legislation and presidential approval is required for any proposed tax law changes. Many tax experts feel Congress is unlikely to deal with major tax provisions until after the election or into early 2013. The November election and possibility of higher taxes magnifies the investor's concerns.

The big tax changes in 2013 include the top tax rate on ordinary income (taxable interest) and short-term capital gains rising to 39.6 percent from 35 percent. Qualified dividends would no longer have the 15% preferential tax rate and would be taxed as ordinary income. Long term capital gains tax rates will increase from 15 percent to 20 percent.

The new Medicare surtax of 3.8 percent on excess net investment income begins in 2013 for taxpayers earning more than the allowed income threshold. Net investment income includes taxable interest, dividends, royalties, rents income, net capital gains, trading income and passive income. Tax exempt bond interest is excluded. This can change depending on the Supreme Court ruling of the Health Care Act.

In addition, significantly higher estate and gift taxes will appear with exemption amounts decreasing to $1 million per person and tax rates increasing to 55 percent. This is a change from a $5 million person exemption and a top tax rate of 35 percent.

Investors tend to underestimate the huge cost of taxes on their investment returns. Very few investors and their advisors consider tax efficiency when managing an investment portfolio. Numerous independent research studies have shown investors without tax-managed portfolios gave up one and two percentage points of their annual return to taxes. This equates to reducing your pre-tax investment returns by approximately 20 percent.

The looming tax increase in 2013 on investment income may be the potential biggest risk to an investor's retirement and money. Now is a good time to consult with your tax advisor to optimize your investment portfolio with tax-efficient strategies and plan for the risk of higher future taxes. Carefully manage your investment portfolio with several tax-wise strategies to reduce the impact on your retirement goals. Investors may find these strategies can help reduce their tax burden and increase their after-tax returns.

Tax-managed investments seek to lower the impact of taxes by minimizing capital gains and actively offsetting gains with losses. These investments are suited for taxable accounts. Generally, the manager seeks to minimize the realization of capital gains when selling securities by selecting shares with long-term gains over shares with short-term gains. Additionally, the manager seeks to identify and sell shares with losses to equalize the realized gains as they manage the portfolio in adherence to the investment policy of the portfolio.

Low turnover investment portfolios tend to be more tax efficient. Short-term trading creates higher turnover and generates short-term gains that are subject to potentially higher tax rates. Using a buy, hold and rebalance strategy can help minimize the turnover and potential higher taxes. Several research studies show rebalancing on a semi-annual or annual basis and using a tolerance range can benefit the investor. Many actively managed mutual funds and separately managed accounts have a high internal turnover ratio as the manager seeks to buy and sell stocks for the fund.

Asset location involves deciding which investments within your portfolio are held in taxable, tax-deferred or tax-free accounts. This simple yet sophisticated strategy is often overlooked by individual investors and advisors. Investors can gain greater tax-efficiency by implementing this strategy. Taxable accounts are regular brokerage and mutual fund accounts that can benefit from lower dividend and capital gain tax rates as well as capital loss deductions. Tax-deferred accounts are traditional retirement accounts like 401(k)s and IRAs and withdrawals at retirement are subject to higher ordinary tax rates. Tax-free accounts include accounts with the Roth feature that allow tax-deferred growth and tax-free distributions.

Tax loss harvesting is the selling of investments with unrealized losses to offset current and future capital gains. The impact of taxes can be lessened with a strategic approach to realize capital losses when the investment declines in value. These losses can be used against current year capital gains and any unused losses can be carry-forward to offset future gains. Tax loss harvesting should be done carefully to avoid the IRS 30-day wash sale rules. To keep market exposure, you can purchase a slightly different stock or fund.

Investors can limit their tax liability by planning and staying abreast of tax debate going on in Washington. You may miss opportunities to adequately plan while waiting or hoping for tax law changes. This can be very costly to your investment income and portfolio. Through tax-wise investing you can potentially reduce the impact of taxes. Control what you can. Now is a good time to start planning for 2012 and beyond.


Stan P. Purvis, CPA, CFP, serves as partner-in-charge of HORNE Wealth Advisors and helps affluent clients make wise choices about their money and wealth. HORNE LLP has served clients across the nation for 50 years. Ranked as one of the top CPA and business advisory firm in the United States, HORNE has offices throughout the Southeast in Mississippi, Tennessee, Alabama, Louisiana and Texas. For more information on HORNE, visit

Published: Thu, May 10, 2012