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Much like the end-times chaos that some had foreseen with the conclusion of the Mayan calendar on December 21, 2012, "Taxmageddon"—the 2013 expiration of previously enacted tax cuts and other tax provisions—never came to pass. That dreaded event was averted by the passage of the American Taxpayer Relief Act of 2012, which President Obama signed into law on January 2, 2013, as the initial step in avoiding the so-called "fiscal cliff." This article highlights notable features of the act that we believe are most important to mutual fund shareholders.
Extension of the Bush-era Tax Cuts
The act extends permanently the so-called Bush-era tax cuts for most taxpayers and addresses certain other expiring tax provisions. The Bush-era tax cuts contain numerous provisions that reduced the amount of taxes paid by most taxpayers. The passage of the act made these expiring provisions permanent for taxpayers earning less than $400,000 ($450,000 for married taxpayers filing jointly. Taxpayers earning more than the threshold should note the following:
Maximum Tax Rates
In addition, the act featured the following changes to maximum tax rates:
Other Provisions of Interest
Effective January 1, 2013, the Affordable Care Act (ACA) requires taxpayers with gross income in excess of the $200,000 ($250,000 married) to pay an additional 3.8% in Medicare tax on the lesser of all net investment income or the amount of income in excess of the threshold. The Medicare tax is independent of and in addition to provisions in the recently passed act. Net investment income includes taxable income and capital gains earned from an individual's mutual fund investments.
New Maximum Tax Rates
Table 1 (below) is a summary of the maximum federal tax rates (inclusive of the Medicare surcharge) for each type of income generated from a mutual fund investment.
Source: Internal Revenue Code and the American Taxpayer Relief Act of 2012.
1 Qualified dividend income is typically paid by funds that invest in equity securities.
2 Nonqualified dividend income is paid by funds that generate income from sources other than dividends (i.e., fixed-income securities).
3 Certain tax-exempt dividends may be subject to state and local taxation, in addition to being considered a tax preference item for the alternative minimum tax.
4 Includes capital gain dividends paid by the fund and gain on sale of shares held for greater than one year.
5 Includes short-term capital gain dividends paid by the fund and gain on sale of shares held for one year or less.
6 Based on taxable income in excess of $400,000 ($450,000 for married taxpayers) for 2013. Indexed for inflation going forward.
7 Based on gross income in excess of $200,000 ($250,000 married) for 2013 and future years. Not indexed for inflation.
The tax portion of the "fiscal cliff" was addressed at the eleventh hour. The resulting act helps avoid "Taxmageddon"; however, most taxpayers will be paying more in taxes during 2013 primarily due to the expiration of the payroll tax holiday. In addition, the inclusion of multiple high-income thresholds, some based on gross income and others on taxable income, only increases the complexity of the tax laws. With all these upcoming changes to the tax law, it may be prudent to discuss potential strategies with your financial and/or tax advisor.
The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.
Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.