If you are like many of your colleagues and peers concerned about the escalating taxes you are paying, you may be looking for ways to offset income from dividends, short and long-term capital gains and taxable interest income, and the taxes associated with this income.

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While not for everyone, one strategy used by many is worth considering if it is important to you to understand your options to offset net investment income and associated federal and state income taxes and the net investment income tax.

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To recap 2024 tax rates for married filing jointly (MFJ) couples:

 

Federal – 2024

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• 32% tax bracket: $ 383,900 to $ 487,459 in taxable income

• 35% tax bracket: $487,450 to $ 731,200 in taxable income

• 37% tax bracket: $ 731,200 + in taxable income

• 20% Capital Gains Income Threshold: $ 583,751+

• Net Investment Income Tax (NIIT):

• The lesser of your net investment income or the excess of your MAGI over $ 250,000

• Social security Tax: 6.2% on up to $168,600 in earned income (per spouse)
  Medicare Tax: 1.45% on all earned income and wages (per spouse)

• Additional Medicare Tax: .9% on earned income above $250,000

• State Disability Insurance (SDI) Tax: 1.1% on all taxable wages

ALERT:

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In 2023, employees paid .9% on taxable wages up to $ 153,164. If you earned $ 700,000 in salary, RSUs and bonuses in 2023, you would have paid $1,378 in SDI tax.

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For 2024, the rate has increased to 1.1% of all wages. If you earn $ 700,000, you will pay $7,700 in SDI tax.
 

While many taxes can’t be controlled, minimizing taxes within your control through strategic tax planning is essential.

California -2024

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• 9.3% on taxable income between $136,701 and $ 698,274

• 10.3% on taxable income between $ 698,275 and $ 837,922

• 11.3% on taxable income between $ 837,923 and $1,396,542

• 12.3% on taxable income above $1,369,543 +

• An additional 1% tax on income over $ 1million per the California Mental Health services Act

• Long-term and short-term capital gains are taxed at ordinary income tax rates

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If you are like many of your colleagues and peers, you are likely earning five or six figures in qualified dividends, short-term capital gains, and long-term capital gains (taxed at your capital gains rate on your federal return and as ordinary income on your California return).

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For many investors in high tax brackets, opportunities to minimize taxes on net investment income are available, and attractive for some, and not attractive for others. Attractive or not, is wise to understand your options. 

Fully-offsetting or partially offsetting net investment income and avoiding associated federal and state taxes on that income is possible for many investors using a calculated strategy to employ the investment interest deduction.   

 

Investment Interest Deduction

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While we are generally not a fan of borrowing to invest, using an investment loan for a modest period and paying the loan back with expected near-term funds, such as 2025 vesting RSUs/GSUs, can be attractive when doing so reduces taxable income, Federal and state income taxes to attractive levels. 

 

Investment interest on investment loans can include interest on a margin loan or HELOC (when funds are used for investment) if the investor has sufficient investment income to deduct the investment loan interest, and the investor is itemizing deductions. If HELOC funds are used, the investor will want to be sure to be able to trace the funds to the investment to support the interest as qualifying investment interest. 

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Qualifying investment interest reduces investment income - including taxable interest, non-qualifying dividends, short-term capital gains. Qualified dividends and long-term capital gains also qualify if an election is made to have these items taxed as investment income. ​

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Example A:

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• Investor X will receive $15,000 in non-qualified dividends in 2024 that will be taxed at his federal margin rate of 37%, plus the 3.8% net investment income tax and at his 10.3% California income tax rate.

• Investor X is considering using his HELOC to purchase a new vehicle for himself and his spouse ($75,000 each) and paying off the loan with 2025 RSUs expected to vest. The interest rate is 10%

• Investor X plans to invest $150,000 in a few stock investments that he expects to have strong appreciation potential. He plans to use cash in his savings account. 

While investor X can pay 51% in taxes on his non-qualified dividends, investor X may want to consider purchasing the vehicles with $150,000 from his savings and using the HELOC to invest $ 150,000 in the new investments. 

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Since investor X itemizes deductions, provided he keeps accurate records of the HELOC funds used to purchase the investments, his $ 15,000 in investment interest expense will offset his $15,000 in net investment income from his non-qualifying dividends, reducing taxable income, and associated federal and state taxes.

Example B:

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• Investor X is delaying selling a long-term appreciated investment valued at $150,000 as he is not happy with the fact the $15,000 gain will be taxed at his 20% capital gains tax rate, plus the 3.8% net investment income tax and his 10.3% California income tax.

• Investor X is considering using his HELOC to purchase a new vehicle for himself and his spouse ($75,000 each) and paying off the loan with 2025 RSUs expected to vest. The interest rate is 10%

• Investor X plans to invest $150,000 in a few stock investments that he expects to have strong appreciation potential. He plans to use cash in his savings account. 

Investor X has the option to make an election to have his net capital gains be included in net investment income.

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While investor X can pay 34.1% in taxes on his capital gain, investor X may want to consider electing to have his net capital gains be included in net investment income and purchasing the vehicles with $150,000 from his savings and using the HELOC to invest $ 150,000 in the new investments. 

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Since investor X itemizes deductions, provided he keeps accurate records of the HELOC funds used to purchase the investments, his $ 15,000 in investment interest expense will offset his $15,000 in net investment income from his capital gain election, reducing taxable income, and associated federal and state taxes.

Example C:

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• Investor X will receive $15,000 in qualified dividends in 2024 that will be taxed at his 20% capital gains tax rate, plus the 3.8% net investment income tax and at his 10.3% California income tax rate.

• Investor X is considering using his HELOC to purchase a new vehicle for himself and his spouse ($75,000 each) and paying off the loan with 2025 RSUs expected to vest. The interest rate is 10%

• Investor X plans to invest $150,000 in a few stock investments that he expects to have strong appreciation potential. He plans to use cash in his savings account. 

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While investor X can pay 34.1% in taxes on his qualified dividends, investor X may want to consider purchasing the vehicles with $150,000 from his savings and using the HELOC to invest $ 150,000 in the new investments. 

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Since investor X itemizes deductions, provided he keeps accurate records of the HELOC funds used to purchase the investments, his $ 15,000 in investment interest expense will offset his $15,000 in net investment income from his non-qualifying dividends, reducing taxable income, and associated federal and state taxes.

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Prior to electing to offset Federal and state taxable income and taxes with this strategy, it is essential to understand all of the rules of the investment interest deduction that apply to your specific situation and interests, and evaluate tax projections for scenarios you are considering, along with projected tax savings and benefits, and understand the risks and rewards.

If you have questions, wish to discuss your specific situation and interests and wish to model projected tax outcomes for Q3 and Q4 decisions and initiatives you are contemplating, we can help.

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Next Steps

 

Give our office a call or provide your contact information below. 

 

Share details important for us to know along with a few dates and times you are available.

Let us know if you prefer meeting in person, over zoom or an initial phone conversation. 

 

We'll review our calendar and confirm one or your preferences or suggest a few alternate options.

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Natalie C. Papagni, CPA | Managing Principal

Cobalt PacWest | CPAs & Tax Advisors

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303 Twin Dolphin Drive # 600

Redwood Shores, CA 94065

650.687.9704

 

4225 Executive Square # 300

La Jolla, CA 92037

858.247.0939