Purchasing municipal bonds has always been a highly effective investment strategy to minimize taxation. Now muni bonds offer even more value to high net worth investors who will find themselves ensnared by the Pease tax rule (along with the PEP rule, the personal exemption phase-out). Pease and PEP basically limit tax deductions for high-income taxpayers. These rules were made idle by the Bush tax cuts, but this year’s fiscal cliff bill reinstates them for 2013.
For folks in South Walton with high AGI’s, this is not encouraging news.
As Jennifer Johnson writes in the Fiscal Times, “The fiscal cliff deal raised federal income taxes on married households who earn more than $450,000 … but the new PEP (Personal Exemption Phase-Out) and Pease limits on the value of personal exemptions and itemized deductions apply for married taxpayers who earn $300,000 …”
Robert McCullar, CPA, of McCullar and Co. in Santa Rosa Beach, who frequently works with clients with high AGI’s, responds to the new tax laws in this fashion: “Once again, middle and upper income taxpayers will … feel the sting of the so-called PEP (Personal Exemption Phase-out), and the Pease Rule (itemized deduction phase-out) … taxpayers were granted temporary relief for the years 2006 through 2009. Other acts of Congress granted full relief for 2010, 2011 and 2012 …”
“But now, the rules that eliminate exemptions and deductions return with full force beginning with tax returns to be filed for 2013,” says McCullar.
The new rules will be felt from Sandestin to Carillon Beach and every stop on 30A in between.
Dividends earned from muni bonds are not subject to federal taxation. And while bonds have taken a beating this year, with some obvious exceptions (Detroit and Illinois paper among them), municipal bonds can still provide some relief for investors with high AGI’s.
In our view, short durations should be the watchword, given the current rising interest rate environment. As always, investors should look hard at the financial health of the issuing municipalities. Very few muni bonds actually default. Convertible bonds, floating-rate bonds and other short-term bonds are considered good choices in this market.
Another type of bond to consider in a strengthening U.S. economy is high-yield bonds or “junk” bonds. The risk of a high-yield bond is that the bond might default and you will lose your capital. But in an economy that is gaining steam, the risk of corporations or municipalities going belly-up is reduced.
Oddly enough, selective equities currently offer less risk than some types of bonds. There are equities, like utilities for example, which pay dividends and act like a bond, providing systematic, periodic income. And price/earnings ratios indicate that it’s not too late to enjoy growth in U.S. equities. Those taxpayers at the steepest end of the brackets (39.6 percent), will also pay a higher rate for capital gains and qualified dividends at 20 percent. It beats paying ordinary income tax but is hardly music to the ears.
Margaret R. McDowell, ChFC, AIF, a syndicated economic columnist, chartered financial consultant and accredited investment fiduciary, is the founder of Arbor Wealth Management, LLC, (850-608-6121— www.arborwealth.net), a fee-only registered investment advisory firm located near Sandestin. Arbor Wealth specializes in portfolio management for clients with $250,000 or more of investable assets.