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D. Frank Norton: Tax rates rising? Watch out, investors

It's Your Money

Posted: May 19, 2010 5:33 p.m.
Updated: May 20, 2010 4:55 a.m.
Whenever we have had significant wealth redistribution legislation, we have seen tax revenue and the nation's economy both decline. I submit we are on the cusp of that happening to us again.

This type of event can adversely affect the value of our investment portfolios if we don't take steps to insulate. We have at least a two-step wealth redistribution now in process.

First, more than likely we will see the capital gains tax rate be increased from 15 percent to 20 percent (and possibly higher) at the start of 2011. A sizeable chunk of investors affected would be the more wealthy investors.

Second, Medicare tax rates are looking to be increased in two ways: First, another .9 percent would be added to the current Medicare tax rate for a total of 2.9 percent. This will affect all taxpayer/wage earners. In addition, the Obama administration is planning to assess practically all investment income with the full Medicare tax rate of 3.8 percent to help pay for the Obamacare package recently passed.

This additional tax will be assessed on single taxpayers earning more than $200,000 and married taxpayers earning more than $250,000. The investment income to be taxed this way will include interest, dividends, annuities, royalties and rents.

In addition, the Obama administration is talking about increasing the dividend tax rate from that of the capital gain tax rate of 15 percent currently to the ordinary income tax rate (the top tax bracket being 35 percent right now, with plans to increase that rate).

What we have here is a disincentive for investing, for capital formation. Even if you as an investor aren't in the above income levels and not affected directly by the additional tax levy on investment income, you can still be affected adversely.

How? By the value of your investment portfolio dropping as a result of this investment disincentive for the more wealthy. The more wealthy may want to reduce their investment holdings to avoid having to pay more tax on the income generated from these investments. When they do that, stock value, as well as value of other investments, tends to fall, which affects all investors.

So how can we protect the value of our investments going forward?

Pare back stock holdings, especially those stock holdings generating high dividends.

Invest in municipal bonds which can generate both state and federal tax free interest. As of this writing, I am not aware of any proposed tax legislation which would add a tax levy on this income.

Consider leveraged rental property if you are affected by this additional tax levy on investment income. The interest, plus other expenses, would be used to offset the rental income, thus keeping the taxable rental income hovering around zero.

Consider other alternative investments, such as fixed income alternatives, which are non-correlated to the stock market. The value of these investments tend not to move in the same direction as the stock market.

I recently returned from an alternative investment conference, where I learned of investment programs that do just that. I suggest you talk to your investment advisor about such investments.

Even though there are investment risks associated with each of the above recommendations, I still be believe that they should be considered where appropriate.

D. Frank Norton is a money manager and financial planner in Santa Clarita. "It's Your Money" appears Thursdays and rotates between a handful of the Santa Clarita Valley's financial professionals. His column represents his own views and not necessarily those of The Signal.


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