New Tax Laws May Aid Your Investment Strategy

If you’re an investor, especially a business owner in the higher tax brackets, you’ll want to pay close attention to some of the provisions of a bill that President Bush signed into law on May 17.

The new legislation extends the lower tax rates on capital gains and stock dividends, temporarily removes restrictions on transfers from traditional to Roth IRAs, and raises the exemption level on the alternative minimum tax (AMT). Clearly, the new laws can have a big impact on your investment strategies over the next few years.

Let’s take a look at the tax law changes and see how they might affect you.


Extension of 15 percent rate on dividends and capital gains

Until a few years ago, dividends were taxed at your personal income tax rate. But changes in tax laws resulted in a 15 percent tax rate on dividends through 2008. I had an appointment with a prospective client this week, who thought he would have to pay taxes at 30+ percent because of how capital gains were taxed years ago. Information about the extension of 15 percent made his day. This rate has now been extended through the end of 2010. Also, the maximum long-term capital gains rate will remain at 15 percent through 2010; this rate, too, was slated to expire at the end of 2008. For taxpayers in the 10-percent and 15-percent brackets, long-term capital gains will be taxed at 5 percent for the 2006 and 2007 tax years and at 0 percent for 2008–2010. Clearly, these changes give you some incentives to look for high-quality, dividend-paying stocks and to hold your stocks for at least one year—long enough to receive the best capital gains rate when you sell. Some stocks have paid, and increased, dividends for 25 straight years or more. These companies are typically well-run businesses that strive to reward their investors. (Keep in mind, though, that no company is obligated to pay dividends and may lower, or discontinue, dividends at any time.) And never hold on to a stock because you don’t want to pay capital gains taxes. You may regret that move if it is a volatile stock.

Removal of restrictions on conversions to Roth IRA

Starting in 2010, you can convert your traditional IRA to a Roth IRA, regardless of your income level. Currently, only taxpayers with adjusted gross incomes of $100,000 or less can make this conversion. The amount you transfer will be included in your gross income, so you’ll have to pay taxes on it, but you can spread the taxes out over two years if you make the rollover in 2010. This traditional-to-Roth conversion may benefit you in at least two important ways. First, qualified withdrawals from a Roth IRA are not taxable. And, second, you won’t have to start taking distributions from your Roth IRA at age 70-1/2, as you must with a traditional IRA and a 401(k).

Increased Alternative Minimum Tax exemption

For many years, many taxpayers have been shielded from the AMT by its large exemption, but this exemption has not been adjusted for inflation, so, as wages and earnings rise each year, more and more people will be subject to the AMT. Recent cuts in income tax rates also mean that more people may face the AMT. The new tax bill provides AMT relief by raising the amount of the exemption to $62,550 for joint filers, $42,500 for singles and $31,275 for married persons filing separate returns. This new exemption level applies only to the 2006 tax year, so when 2007 rolls around, watch for the results of new legislation. By the way, if your advisor recommends tax free bonds to you, make sure that they are not subject to AMT. If they aren’t, they are no different than a taxable bond.

So, there you have it—news you can use about the new tax laws. Consult with your investment professional and tax advisor to see how you can benefit from these changes.

For any questions or comments, please contact Jesse Abercrombie, investment representative, 972-241-8059.

Jesse Abercrombie
Jesse is a financial adviser with 14 years of experience in the industry. He is experienced in working specifically with construction business owners and executives, along with centers of influence, to build customized investment strategies. He also focuses on helping individuals with their financial strategies during life events such as divorce. Jesse works in tandem with CPAs and estate and family law professionals to help service client financial goals and objectives.