Health Care and Government and Real Estate & Retail

BULLS & BEARS: Answers to tax questions are sometimes surprising

July 2, 2007

Taxes are always a consideration in investment decisionmaking. Investors need to be vigilant to changes in the tax code, because from year to year there may be changes that can affect the choices they make.

And while there are some broad tax generalities, an individual's tax profile is specific to that person. Navigating the tax code can be daunting. Yet with some tedious reading and a strong dose of common sense, investors can arrive at rational decisions. I have found the Internal Revenue Service Web site to be well-organized and helpful when searching for answers to tax questions.

One of the difficult things an investor has to deal with in tax-related decisions is that, much like investing, you have to make decisions with unknown variables, such as future tax rates. And sometimes the best course is not always as cut and dried as it might seem at first blush.

For example, at first glance it may intuitively appear that stocks paying highdividend yields are excellent candidates to place in retirement accounts, where the tax can be deferred. For instance, these four stocks in the Dow Jones industrial average have dividend yields above 4 percent: Pfizer, Citigroup, Altria and Verizon. Given the option of buying them in a taxable account or a tax-deferred account, one might initially select the retirement account.

But under the tax code, it may be more beneficial to hold these stocks in a taxable account. Stocks that pay "qualified dividends" receive favorable tax treatment, and at present those dividends are taxed at a maximum rate of 15 percent. (Most corporate dividends meet the criteria for qualified tax treatment-careful, though, as most real estate investment trusts do not.) In addition, if you are a long-term investor, you already enjoy tax deferral, since your capital gains tax is not due until you choose to sell the stock. Upon sale, the current maximum capital gains tax rate is 15 percent.

Contrast this with investments in taxdeferred retirement accounts. Here, the withdrawals that most investors will make in their retirement years are taxed at ordinary income tax rates. It is not uncommon for individuals with a healthy retirement balance, and who take withdrawals to sustain their lifestyle, to land in the higher tax brackets. Thus, holding high-yielding stocks with qualified dividends in a taxable account is not as foolish as it might first seem.

There are a multitude of tax issues investors face. The alternative minimum tax is snaring more people these days. Also, many investors should at least investigate the math of converting a traditional IRA into a Roth IRA.

So while there is an element of uncertainty in tax planning, there is one thing predictable about taxes and that is that they are sure to increase, whether on income, sales or property. All levels of government face funding pressures. Particularly looming are the pension and health care liabilities that will have to be met with higher tax assessments. And, of course, with a change of administration coming in little over a year, there certainly will be tinkering with the tax code.

If you find your tax planning is too confusing or don't have the time or interest in thinking through it, seek out a tax professional who can assist you.



Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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