Little things can make a big difference on your tax bill

Calculating the cost of taxes on investment income is more complicated than most people realize.

Consider this too – if you don’t get a handle on some important numbers prior to year-end, you could wind up paying a lot more in taxes. Investment decisions and associated income can have a dramatic effect on brackets. It’s important for your financial advisor and tax preparer to communicate regularly to create collaborative strategies on your behalf. If that’s not happening, you may get shocking news on what you owe at filing time.

Understanding tax calculations

There are three primary tax-related items to consider when building the fixed income allocation of your portfolio. Not paying attention to any one of these can push you into a new tax bracket unnecessarily.

Tax-equivalent yield: Calculating this figure is important if you want to effectively compare the yield on taxable and tax-exempt investments. It doesn’t require complex math but can mean a big difference in the amount of money you have when you need it. To find it, you take the tax-exempt yield and divide it by {one minus your marginal tax rate}. So, if you’re in the 35% marginal federal tax bracket and are looking at a bond with a yield of 3.33%, you’d divide .033 by {1 – .35} to get a taxable equivalent yield of 5.08%.

Most people don’t know their marginal tax rate. This is a progressive tax bracket that comes from a blended tax rate. Your tax professional or CPA should be able to provide this number quickly and easily if you don’t know what it is.

Alternative Minimum Tax (AMT): The AMT is Uncle Sam’s way of making sure certain individuals and entities pay their fair share. It’s a supplemental income tax that gets levied when standard income tax payments are deemed too low. This is most often applicable to filers with substantial capital gains or those the IRS deems is getting too many tax benefits. It’s important for your financial advisor to know if you are subject to paying AMT because if you are, interest from normally tax-except private activity bonds (such as those issued to pay for stadiums, hospitals, house projects and other qualified ventures) will be added back as a preference item and could be taxed at a rate of 28%.

Social Security “Stealth Tax:” Did you know you could be taxed on up to 85% of your Social Security payments? Determining how much of your Social Security income is taxable is anything but straightforward. The Internal Revenue Service looks at “combined income,” which includes your adjusted gross income, tax-exempt interest income and half of your Social Security benefits if it’s $25,000 or more for a single filer. If your combined income exceeds $34,000 as an individual, or $44,000 on a joint return, up to 85% of your Social Security benefits may be taxed. If you are on the cusp, your decisions about producing investment income could have a significant impact on the taxation of your Social Security benefits.

That $100 difference could mean thousands

Sadly, many have discovered after it’s too late that they could have saved thousands in taxes if it weren’t for that $100 that put them over the threshold. This can be particularly painful with capital gains where the higher percentage is applied to every dollar earned. Tiny adjustments made in December can make a huge difference in what you owe come April.

360 Tax Solutions and 360 Financial Solutions operate under the same roof with professionals who collaborate regularly on your behalf to ensure investments and tax strategies align. If your tax and investment advisors aren’t talking to each other throughout the year and particularly in December, you might wind up paying dearly.