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Muni Demand Likely to Get A Boost by Health Care Tax

CHICAGO — The 3.8% investment tax that is part of the new federal health care law is expected to boost demand for tax-free municipal bonds starting in 2013, according to market experts.

“Anytime you have a tax increase, it helps munis because the exemption just makes it a more attractive investment,” said Howard Cure, director of municipal research for Evercore Wealth Management LLC.

“I think that a lot of people are waiting for the [presidential] election to see if that specific tax, as well as the Bush tax cuts expiring and other fiscal decisions, to see what’s going to happen,” Cure said.

Income tax rate cuts adopted during the administration of President George W. Bush will expire Dec. 31 without congressional action.

The Internal Revenue Service has not yet released guidance on the new investment tax.

According to the law, passed by Congress in 2010, the 3.8% surtax applies to investment income of joint filers with adjusted gross income of more than $250,000 and single filers with income above $200,000. The tax applies only to investment income above the threshold.

Interest from municipal bonds will not only be exempt from the 3.8% tax but also will not count toward a filer’s overall investment income, making munis doubly attractive, according to some observers.

If the current tax rates are extended, the new health care tax will raise the overall tax rate on long-term capital gains and dividends to 18.8% from 15% starting on Jan. 1, 2013. If the Bush tax cuts are allowed to expire, the top tax rate on capital gains will rise to 23.8% and the top rate on dividends will go up to 43.4%.

The new investment tax is set to take effect next year, assuming President Obama wins re-election in November and the new law is maintained.

“Demand will go up moderately,” said Bart Mosley, co-president of Trident Municipal Research. “To the extent that the tax bite is higher, it makes more sense to invest in munis, and there will be a moderately positive impact on the demand side.”

Brian Roehl, a senior financial advisor at Michigan-based investment firm LJPR LLC, said he thinks the new tax could mean a big boost for munis. “We think it’s going to create a huge demand, especially for premium municipal bonds,” he said.

Cure noted that increased demand could be offset by less demand from those earning below the new threshold, who might want to shed munis if prices rise.

Image: Shutterstock

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The article's statement that "The [3.8%] tax applies only to investment income above the threshold" is incorrect or, at best, ambiguous.

The tax applies to the lesser of (1) net investment income or (2) the excess of modified adjusted gross income over the applicable threshold.

Example: Assume a joint filing married couple with 500,000 of compensation and 100,000 of investment income. All 100,000 of the investment income is subject to the tax, which applies to the lesser of (1) net investment income (100,000) or (2) the excess of modified adjusted gross income (600,000) over the threshold (250,000), or 350,000.

Put another way, all investment income, regardless of amount, will be subject to the tax if the joint filing couple's compensation is at least 250,000.
Posted by pepperlawlib | Friday, July 20 2012 at 3:52PM ET
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